Production Theory

(Content: Prof. Vishwa Ballabh)

The Production Function specifies the maximum output that can be produced for given amount of inputs, it can be denoted as Q = f(X1,X2……Xn)

Some of the most important questions related to production would be:

• how much to be produced to maximize profit once the quantity of production is decided
• how to use the available resources to produce the intended quantity
• if the resources are limited, what should be the ideal combination in which they are used and what should be the output
• how to increase / decrease production in the short / long run

A production table shows the quantity of output generated against the units of inputs employed in production. For the sake of simplicity, let us take X and Y as inputs for producing Z. There may be several combinations of inputs X and Y that produce N quantity of the output Z. If we plot these combinations in a graph, the resultant curve is called as an Isoquant.

Short run Production Function

It is the maximum output that can be obtained by combining various levels of variable inputs to a given level of fixed resources. You can denote it as Q = f(X1, / X2, X3...Xn) where X1 is the variable input and all others are fixed inputs. Our intention is to find out how the production changes when we keep on increasing X1 and therefore how much X1 should be used in order to maximize profit.

Productivity Concepts

Total Product is the maximum output for a given level of variable input, Q = f(X1/...)
Marginal Product is the additional output produced by one additional unit of input while other inputs are held constant, MP = (change in TP / Change in level of input)
Average Output is the total output divided units of variable input, AP = TP / Number of variable inputs

Law of Diminishing Returns

This law states that the additional output from successive increase of one input will eventually decline when other inputs are held constant. This means marginal product of the varying input declines after a point. Example: Lets take a simple example of making N pieces of Z with O pieces of X, if we increase the input to O + 1, output may become N + 1, however if the input is increased to O + 2, the output may not be N + 2, instead it will be N + 1.75 and so on.