Transcript of The Theory of the Firm Meaning of function The word function is derived from mathematics. It...
- Slide 1
- Slide 2
- The Theory of the Firm
- Slide 3
- Meaning of function The word function is derived from
mathematics. It establishes the relationship between two variables.
It explains the extent to which one variable depends upon another.
For example demand and price,output and input, expenditure and
income.
- Slide 4
- Production Function
- Slide 5
- Meaning of Production Function Production function analyses the
physical relationship between input and output. Production function
means functional relationship between physical inputs of factors of
production and physical output of a firm. It indicates maximum rate
of output that can be obtained from different combinations of
productive factors during a certain period of time and for a given
state of technical knowledge. The production function is a
technical or engineering relationship between output and input. As
long as the natural laws of technology remain unchanged, the
production function remains unchanged. Prof. L.R.Klein
- Slide 6
- Production Function States the relationship between inputs and
outputs Inputs the factors of production classified as: Land all
natural resources of the earth Price paid to acquire land = Rent
Labour all physical and mental human effort involved in production
Price paid to labour = Wages Capital buildings, machinery and
equipment not used for its own sake but for the contribution it
makes to production Price paid for capital = Interest
- Slide 7
- Production Function Mathematical representation of the
relationship: Q = f (K, L, La) Output (Q) is dependent upon the
amount of capital (K), Land (L) and Labour (La) used
- Slide 8
- Production Function InputsProcessOutput Land Labour Capital
Product or service generated value added
- Slide 9
- Characteristics It establishes relationship between physical
quantities of output and inputs This is an engineering problem No
change in technology Production function should be considered with
a particular period of time Inputs can be easily substituted It can
be related to short period or long period Divisibility or
indivisibility of factor should be taken into account.
- Slide 10
- Kinds of production function One variable and two variable
production function Production function for a firm and for an
industry Short run and long run PF Homogeneous and Heterogeneous PF
PF= production function
- Slide 11
- Analysis of Production Function: Short Run In the short run
only one or two factors can be changed by keeping other factors
constant. Reflects ways in which firms respond to changes in output
(demand) Can increase output up to a certain level. It is
associated with law of variable proportions.
- Slide 12
- Analysing the Production Function: Long Run The long run is
defined as the period of time taken to vary all factors of
production By doing this, the firm is able to increase its total
capacity not just short term capacity Associated with a change in
the scale of production The period of time varies according to the
firm and the industry In electricity supply, the time taken to
build new capacity could be many years; for a market stall holder,
the long run could be as little as a few weeks or months!
- Slide 13
- Analysis of Production Function: Long Run In the long run, the
firm can change all its factors of production thus increasing its
total capacity. In this example it has doubled its capacity.
- Slide 14
- Slide 15
- The Production function expresses a functional relationship
between quantities of raw materials and output. It shows how and to
what extent output changes with variations in raw materials during
a specified period. In the words of Stigler The production function
is the name given to the relationship between rates of input of
productive services and the rate of output of product. It is
economists summary of technical knowledge. It is expressed as
follows. __ Q =F (L,M,N,C,T), where Q stands for the output of a
good per Unit of time, L for labour, M__ for management of
organisation, N for land or natural resources, C for Capital and T
for given technology and F refers to the functional
relationship.
- Slide 16
- Basic concepts related to production or law of returns Short
run Long run Fixed factors Variable factors Levels of production
Scale of production
- Slide 17
- Total product, Average Product and Marginal Product The total
product of a factor identifies the total volume of goods produced
by a given amount of factors of production during a certain period.
This can be displayed in either a chart that lists the output level
corresponding to various levels of input, or a graph that
summarizes the data into a total product curve. The diagram shows a
typical total product curve. In this example, output increases as
more inputs are employed up until point A. The maximum output
possible with this production process is Qm. If units of input are
increased after this point, TP starts to decrease.
- Slide 18
- Average and Marginal product The average physical product is
the total production divided by the number of units of variable
input employed. It is the output of each unit of input. If there
are 10 employees working on a production process that manufactures
50 units per day, then the average product of variable labour input
is 5 units per day. The marginal physical product of a variable
input is the change in total output due to a one unit change in the
variable input.
- Slide 19
- Average and Marginal Physical Product Curves
- Slide 20
- Mutual relationship between TP, AP and MP As the quantity of
variable factor of production is increased, TP also increased TP is
maximum when MP is zero. TP and AP never can be zero If the
quantity of variable factors of production is increased after MP
has become Zero, it will not increase TP rather it will start to
decline. At the initial stage TP increases at increasing rate and
at the ultimate stage TP increases at a diminishing rate.
- Slide 21
- Laws of returns or Law of Variable of Proportions Production of
a commodity is the result of combined efforts of various factors of
production. These factors of production can be classified as fixed
and variable factors. To increase the quantity of production,
quantity of the factors of production will have to be increased.
But the increase in production in response to a given increase in
factor of production is not always same. Such behavior if
production is explained by Laws of Returns.
- Slide 22
- If one input is variable and all other raw materials are fixed
the concerns production function exhibits the law of variable
proportions. If the number of units of a variable factor is
increased, keeping other factors constant, how output changes is
the concern of this law. As per Leftwich The law of variable
proportions states that if a variable quantity of one resource is
applied to a fixed amount of other input, output per unit of
variable input will increase but beyond some point the resulting
increases will be less and less with total output reaching a
maximum before it finally begins to decline.
- Slide 23
- Postulations This law is based on the below postulations. It is
feasible to alter the proportions in which the a range of factors
are collective Only one factor is erratic while others are held
invariable All units of the changeable factor are standardized
There is no variation in expertise It presumes a short run
condition The produce is calculated in physical units, in quintals,
tons etc. The price of the produce is specified invariable
- Slide 24
- Types of laws of returns Prof. Marshall propounded three types
of laws of returns- Law of increasing returns Law of constant
returns Law of diminishing returns
- Slide 25
- Law of increasing returns When increase in output is in greater
proportion than increase in input, it is known as law of increasing
returns. In other words When proportionate change in production is
more than the proportionate change in the quantity of variable
factors of production by keeping the fixed factors constant, it is
called the law of increasing returns. Units of labour TPAPMP 110
2241214 3451521 4681723 5951927
- Slide 26
- Causes to apply laws of increasing returns Economies of
division of labor and specialization Saving of time and improvement
in the technique of production Economies of the use of Specialized
Machinery Economies of Buying and Selling
- Slide 27
- Law of constant returns Law of constant returns states the
situation when increase in production is just equal to the increase
in input so, AP and MP remain constant. Units of labour TPAPMP 110
22010 33010 44010 55010
- Slide 28
- Law of diminishing returns Law of diminishing returns occupies
an important place in economic theory. This law explains the stage
of production in which the quantity of one input of production is
increased with a fixed quantity of other inputs and the resulting
increase in production decreases after a certain point Law of
diminishing returns states the situation when increase in
production is less than increase in input so, AP and MP will
eventually decline.
- Slide 29
- Law of diminishing returns Units of labour TPAPMP 110 2199.59
32798 43386 5377.44
- Slide 30
- Assumptions Technology remains same Organizational structure
and managerial efficiency of the firm remain unchanged It is also
assumed that there are some inputs which quantity may be kept fixed
and the quantity of other inputs may be changed, as required. This
law will not apply if all the factors of production are
proportionately changed. All the units of variable factors are
homogenous This law is related to the physical quantity not with
its value It is essential for the operation of this law that the
optimum combination of resources of production must have already
been achieved because this law applies only after this stage.
- Slide 31
- Causes of the operation Fixity of one or more factors of
production Scarcity of productive resources Going beyond the
optimum combination Factors of production are not perfect
substitute for one another
- Slide 32
- Significance Universal application Base of Malthusian
population theory Base of Marginal Productivity Theory Base of
Determination of Standard of living Responsible for migration of
population
- Slide 33
- Explanation of the Law To explain this law more clearly, let us
construct a sketch.
- Slide 34
- The TP curve first rises at an enhancing rate upto point A
where its slope is highest. From point A upwards, the total product
increases at a diminishing rate till it reaches its highest point C
and then is starts falling. Point A where the tangent touches the
TP curve is called the inflection point upto which the total
product increases at an increasing rate and from where it starts
increasing at a diminishing rate. The average product curve AP and
the marginal product curve MP also raise with TP. The MP curve
reaches its maximum point D when the slope of the TP curve is the
maximum at point A. The maximum point on the AP curve is E where it
coincides with the MP curve. This point also coincides with point B
on the TP curve from where the total product starts a gradual rise.
When the TP curve reaches its maximum point C, the MP curve becomes
zero at point F. When the TP starts declining the MP curve becomes
negative, i.e. is below X axis. The rising, the falling and the
negative phases of the total, marginal and average products are in
fact the different stages of the law of variable proportions which
are discussed below.
- Slide 35