PRODUCTION FUNCTION

1. Production Function – It is an expression of the technological relationship

between physical input and output of a good.
Or Production Function is the relationship between physical inputs (land,
labour, capital, etc.) and physical outputs (quantity produced). It is a technical
relationship (not an economic relationship) that studies material inputs on one
hand and material outputs on the other hand. Material inputs include variable
and fixed factors of production. In a standard equation, the Production
function is represented by Q, Labour (Variable factor) is represented by L, and
Capital (Fixed factor) is represented by K.
Q = f(L,K)
Qx = f(i1 , i2 , i3 ,……… in ) = f(L,K) where L is land and K is capital and Q is
Output
Assumptions of Production Function
1. Both inputs and outputs are divisible and equally efficient.
2. There are only two factors of production, i.e., land (Variable element) and
capital (Fixed element).
3. Factors of production are imperfect substitutes.
4. Technology is constant.

Types of Production Function

Production function on the basis of the time period can be divided into two
categories: Short Run Production Function and Long Run Production Function.
In these production functions, the combination and behaviour of variable
factors and fixed factors are different.
1. Short Run Production Function: Short Run is a period of time where
output can only be changed by changing the level of variable inputs. In the
short run, some factors are variable and some are fixed. Fixed factors
remain constant in the short run like land, capital, plant, machinery, etc.
Production can be raised by only increasing the level of variable inputs like
labour. Therefore, the situation where the output is increased by only
increasing the variable factors of input and keeping the fixed factors
constant is termed as Short Run Production Function. This relationship is
explained by the ‘Law of Variable Proportions.’
2. Long Run Production Function: Long Run is a span of time where the
output can be increased by increasing all the factors of production whether
it is fixed (land, capital, plant, machinery, etc.) or variable (labour). Long
run is enough time to alter all the factors of production. All factors are said
to be variable in the long run. Therefore, the situation where the output is
increased by increasing all

the inputs simultaneously and in the same proportion is termed Long Run
Production Function. This relationship is explained by the ‘Law of Returns
to Scale.’

Short run Long run

 The period in which output can be The period in which output can be
changed by changing only variable changed by changing all factors.
factors.
Factors are classified as fixed and All factors are variable factor.
variable factor.
Demand is more active in price Demand and supply both play equal
determination. role in price determination.
Difference between Short run and Long run:-

Difference between Variable factor and Fixed factor:-

Variable factor Fixed factor
Those factors which can be changed Those factors which cannot be changed in
in short run. short run.
They vary directly with output. They do not vary directly with output.
Variable factors can be zero when Fixed factors cannot be zero if output is zero
output is zero.
Raw material, casual labour, power Building, plant and machinery, wages
etc. are the examples. permanent labour are the examples.

Types of Product:- The product concept can be seen from three different
perspectives:
1. Total Product
2. Marginal Product
3. Average Product

a) Total Product- Total quantity of goods produced by a firm during a given

period of time with given number of inputs.
TP = AP x Output = ∑MP
b) Average Product- Its total output per unit of variable input.
AP = TP/Variable Factor
c) Marginal Product- It is addition to total product when one more unit of
variable factor is employed.
MP = TPn – TPn

Numerical Example of TP, AP and MP

Example 1:
Calculate AP and MP from the following particulars:

Solution:
 Relationship between TP and MP: Let’s take an example to understand the
relationship between TP and MP.

Observation:
1. As long as the Total Product (TP) increases at an increasing rate; i.e., till
point P, MP also increases.

2. When TP increases at a diminishing rate, MP also decreases. In this case,

it starts happening when 4 units of labour are employed and continues till 6
units of the variable factor.
3. When TP reaches its maximum point; i.e., point M, MP becomes zero; i.e.,
point N.
4. Ultimately, when TP starts decreasing, MP becomes negative; i.e., from
the 7th unit.

Relationship between AP and MP:

 Observation:
1. As long as MP is more than AP, AP rises. In this case, AP rises up to the
3rd unit of the variable factor.
2. When MP is equal to AP, AP is at its maximum; i.e., at the 4th unit of the
variable factor.
3. When MP is less than AP, AP falls; i.e., from the 5th unit of the variable
factor.
4. Ultimately, both AP and MP fall but MP becomes negative and AP remains
positive. Also, MP falls at a faster rate as compared to the fall in AP.

Returns to a factor (Law of Variable Proportion):-

Definition and assumption- The law states that as we increase quantity of
only one input keeping other inputs fixed, TP initially increases at an
increasing rate then at a decreasing rate and finally at a negative rate.
Assumptions –
I) It is a short run concept and applies to production only.
II) Factors are classified as fixed and variable factor.
III) Factors of production are imperfect substitute to one another.
It is explain with Tabular and Graphical presentation:-

Fixed Variable
Factor Factor TP MP
(Land) (Labour) (units) (units) Phase

1 1 5 5
Phase I: Increasing
Returns to a Factor
1 2 20 15

1 3 32 12

Phase II: Decreasing

1 4 40 8
Returns to a Factor

1 5 40 0
 Phase III: Negative
1 6 35 -5
Returns to a Factor

. Phases of Law of Variable Proportion:

Phase I: Increasing Returns to a Factor (TP increases at an increasing
rate) In the initial stage, each additional variable component raises the total
production by an increasing amount. This indicates that each variable’s MP rises and
that TP rises at an increasing rate.

Phase II: Decreasing Returns to a Factor (TP increases at a decreasing

rate) : Every extra variable in the second phase increases the output by a less and
smaller amount. This indicates that when the variable factor increases, MP decreases,
and TP rises at a decreasing rate. This stage is known as the diminishing returns to a
factor.

Phase III: Negative Returns to a Factor (TP falls): The third phase shows a
decline in TP due to the use of more variable factors. MP has now become negative.
As a result, this stage is referred to as negative returns to a factor.

Reasons for Increasing Returns to a Factor (Phase I)

The operation of increasing returns to a factor is carried out for three key reasons:

1. More Effective Use of Fixed Factor: In the initial stage, a number of fixed
factors are available, while there aren’t enough variable factors. The fixed factor is
therefore not completely utilised. The fixed factor is better used, and output increases
at an increasing rate when the variable factors are increased and combined with fixed
factors.

2. Increased Efficiency of Variable Factor: The variable factors must be increased

and combined with the fixed factor, in order to use the former more efficiently.
Besides, there is a high degree of specialisation and increased cooperation among the
different units of the variable factors.

3. Fixed Factor Indivisibility: In general, fixed factors that are integrated with
variable factors are not divisible. It means that these elements cannot be divided into
smaller parts. As more units of the variable components are given, the utilisation of
the fixed factor improves after an investment has been made in an indivisible fixed
factor. As long as the ideal level of variable and fixed factor combination is attained,
increasing returns is applicable.

B. Reasons for Decreasing Returns to a Factor (Phase II)

The occurrence of diminishing returns to a factor is due to these three key reasons:

1. Optimum Combination of Factors: There is only one optimal combination

between a variable and a fixed factor where the overall product is maximum. The
marginal return of the variable factor begins to decrease after the fixed factor has
been utilised to its fullest potential. For instance, if a machine (fixed factor) is being
used to its full potential with 4 workers, adding a fifth worker will only slightly
improve TP, and MP will begin to decline.

2. Over-utilization of Resources: The fixed component finally reaches its limits and
begins to produce diminishing returns as one continues increasing the variable factor.

3. Imperfect Substitutes: Fixed and variable factors are imperfect substitutes for
one another, which results in diminishing returns to a factor. There is an extent to
which one factor of production can be substituted for another. For instance, until a
certain point, capital may be used in place of labour or labour may be used in place of
capital. Beyond a certain point, they start to lag behind each other and produce
declining returns.

C. Reasons for Negative Returns to a Factor (Phase III)

The occurrence of negative returns to a factor is due to these three major reasons:

1. Limitation of Fixed Factor: The reason why some production factors have
negative returns is that they are fixed in nature and cannot be raised in the
short run together with an increase in the variable factor.

2. Lack of Coordination: When the variable factor dominates the fixed factor, they
interfere with one another. It causes a lack of coordination between the fixed and the
variable factor. As a result, total output falls rather than rises, and the marginal
product becomes negative.

3. Decrease in Efficiency of Variable Factor: The benefits of specialisation and the

division of labour begin to diminish as variable factors continue to increase. It causes
inefficiencies of variable factors, which is another element that finally leads to
negative returns.

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