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Production and Costs

Introduction to Production Function, Short Run v/s Long Run, Isoquants

Objectives

After going through this chapter, you shall be able to understand the following concepts.

  • Concept of Production and Production Function
  • Factors of Production and its types
  • Concept of Short Run and Long Run
  • Isoquant/Isoproduct Curve and its Properties

Introduction

Production implies creation of goods and services with the sole motive of selling them in the market usually to earn profit. A producer in order to undertake the production process requires some basic prerequisites. These prerequisites are called inputs. The final product produced is called output. Let us understand this with the help of an example. A motor-cycle producer needs steel (raw materials), workers (labour), money (capital), building and avenue (land) for producing motor-cycles. All these requirements are known as inputs or factors of production and the product (motor-cycle) produced is known as output

Theory of Production/Producer Theory

As we know that the Theory of Consumer Behaviour focuses on how a rational consumer forms his consumption decisions, how much to consume at what price, how to maiximise his satisfaction, how a consumer attains equilibrium, etc. Similarly, the Theory of Production focuses on how a rational producer forms his production decisions, how much to produce, how to minimise the cost of production and maximise the profit, how a producer attains equilibrium, etc. Producer Theory can be sub-divided into following two theories.

1. Theory of Production- The basic focus of this theory is on how a particular producer makes his production decisions, how much to produce, etc.

2. Theory of Cost- This theory primarily emphasises on the cost of production, how a producer can minimise his cost of production to maximise his profit. 

Production Function

The production function of a firm depicts the relationship between the inputs used in the production process and the final output produced. It specifies how much units of different inputs are needed in order to produce the maximum output. Algebraically, a production function can be represented as:

Qx = f (L, K)                    (1)

where,

L represents units of labour used (input one)

K represents units of capital used (input two)

Qx represents units of output x produced (output)

The equation (1) is explained as Qx units of output x are produced by employing L units of labour and K units of capital by given level of technology. A particular production function is associated with is a given level of technology. If the production technology appreciates (or depreciates), then the maximum level of output increases (or decreases) employing the same input combinations of labour and capital.

Note: As per the Class-XII syllabus, we will analyse and study two inputs production function, i.e. labour and capital as inputs.  

Factors of Production and Factor Incomes

The inputs used in the production process are called factors of production. These factors are compensated by the producer in exchange of their services and contribution to the output produced. The compensation to the factors in monetary terms is called factor incomes such as, rent, wage, interest and profit. There are four main factors of production namely, land, labour, capital and enterprise.

Land- In economics, land does not merely imply soil. In fact, it broadly refers to all the natural resources, flora and fauna, earth, building, avenues, air, water, minerals, etc. The owner of land (landlord) receives rent in exchange of his contribution to the production process.  

Labour- It includes all physical and mental efforts of workers, employees, managers, etc. A labourer receives wages in return of his services in the production process.

Capital- It includes money invested in the business, machinery and tools. A money-lender or capital owner receives interest on the amount of capital contributed by him in the production.  

Enterprise- It includes the skills and efforts of the entrepreneur or the owner of the production. An entrepreneur organises the production process by hiring all the services of all the above factors to produce output. He sells the output in the market and remunerates the factor. In exchange of his dare to undertake risk of production, he receives profits in exchange.

 

Factors of Production

Owners of Factors

Factor Incomes

Land

Landlord

Rent

Labour

Labourer

Wage

Capital

Moneylender

Interest

Enterprise

Entrepreneur

Profit

Note: It should be noted that while the factor incomes are the incomes for the factors, on the other hand, it is regarded as cost of production from the producer’s (or firm’s) point of view.

Types of factors of Production

The factors of productions are classified as:

  1. Variable factors of production
  2. Fixed factors of production

Variable Factors of Production- Those factors which can be increased or decreased as per the need to increase or reduce the units of output are called variable factors. The output can be increased or decreased by employing more or less units of variable factors, ceteris paribus. Output is a positive function of variable factors, i.e. at zero level of output no (zero) variable factors are employed and as we increase the employment of variable factors, output also increases simultaneously. 

Example- Labour is an example of variable factor of production.

Fixed Factors of Production- Those factors which remain constant with the change in the output level are called fixed factors of production. These fixed factors remains constant even at the zero level of output. Let assume that a machine can produce maximum 500 units of output. In this case, fixed factor remains same for all the output units in the range of 0 to 500. That is, the increase in the output units from 0 to 500 can be brought in without changing the fixed factors

Example- Capital such as, building, plant and machinery, etc. are some of the examples of fixed factors of production.

SHORT RUN AND LONG RUN

In economics, time horizon has been divided into two periods- Short run and Long run. There is no explicit base on which such demarcation has been made. That is, the concept of short run and long run may differ from firm to firm on the basis of its nature. For example, for a shoe producing firm, short run implies a period of less than 1 year but for a dam constructing firm, short run may not be less than 8-10 years. 

Short Run

In short run, a firm cannot change all its inputs. This implies that the output can be increased (or decreased) by employing more...

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