51633013 the Production Process Ppt

8/13/2019 51633013 the Production Process Ppt

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THE PRODUCTIONPROCESSProduction is a process in which

economics resources or inputs arecombined by entrepreneurs to

create economic goods and

services


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THE PRODUCTION FUNCTION

The task of a production unit is toorganise a production process aprocess of combining the different

factors in some proportion so thatthose inputs can be efficientlytransformed into products or

outputs.


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The production function

INPUTS

Factors

Factors ofproduction

Resources

OUTPUTS

Quantity (Q)

Total product(P)

Product


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Mathematical statements

Q=f(X1,X2 ...........................XK)Where Q=Output, X1X2=Inputs used

For the purpose of analysis, the equation can be reduced to two inputs Xand Y.

Q=f(X,Y)

Where Q=outputX=LabourY=Capital

The production function defines the relationshipbetween inputs and the maximum amount that

can be produced within a given period of timewith a given level of tecnology


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The Nature of production

1. The production function is purelytechnological.

2. Production function is a continuousfunction

3. Production function has economicimportance

4. Production functions differ from firmto firm and industry to industry


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Nature of production

function

Purely technological

Economic Importance

Continuous functionDiffer from

firm to firm


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Types of production function

1. Fixed proportion and variableproportion production function

2. Short period and long periodproduction function

3. Cobb-Douglas production function.


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The fixed proportion production function


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Variable proportion production function

a

b

c

100

200

300

Labour

C

a

p

i

t

a

l

ox1 x2 x3

y1

y2

y3


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Production function through

Iso-Quants analysis

Iso-Quant curve

It is a concept which tells that the quantityproduced will be same inspite of variation inproduction.

There may be different combination of inputs. Eachcombination is called a scale of preference. Eachscale when applied will produce the samequantity of output. Thus,

Iso-Quant (which means equal quantity) curveindicates that each curve will have differentscales of preference of input which can producethe same quantity of ouput


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ILLUSTRATION

Two variables inputs namely capital (k)and labour(l) are considered. Total outputis Rs 100 labour cost is Rs 10 per unit andcapital cost is Rs 30 per unit some

alternative combinations are as follows: Combination Capital Labour 1 3 1 2 2 4

3 1 7

Pl tti th b t bi ti


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Plotting the above cost combination

we get the isocost line as follows

0 1 22 3 4 5 6 7 8

1

2

3

4

5


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When outlay is increased prices of factorsremaining unchanged, factor combination willchange with more quantities of factors beingpurchased. For each increase in total outlay theisocost lines will be different and shift upwards.Prices of factors remaining unchanged the isocostlines will have parallel shifts.


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Properties of isoquants1 Isoquants are convex to origin: The slope of the isoquant

measures, the marginal rate of technical substitution of

one factor input(say labour) for other factor input(saycapital).2 Isoquants are negative slope: This means that in order to

maintain a given level of output when the amount of onefactor input is increased other must be decreased.

3 Isoquants never intersect each other: This is necessary

because by definition each isoquant represents a specificquatum of output. Therefore if two isoquants intersecteach other it would involve logical contradiction asparticular isoquant at time may be representing a small aswell as a large quantity of output.

4 Isoquants never touch axis: Isoquants do not intercept eitheraxis because if it touches it would mean that output ispossible by using single factor, but this is unrealistic.

5 Sometimes isoquants are oval shape: One isoquant may havepositive upwards slope at its ends. When with relativelysmall amount of factor realtive large amount of factor iscombined marginal productivity of abundant tends to benegative and as such resulting in decline of total output. In

such cases the end positions of curves are calleduneconomical.


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Marginal rate of technical

substitution (MRTS)

The producers substitute are input in the place ofother in the production process. The substitutingof one input for another without changing thelevel of output is called as marginal rate of

technical substitution. The scope of isoquant ismeasured in terms of MRTS. The MRTS of factorx(labour) for a unit of factor (y) which can besubsituted or replaced for a unit of x without

changing the level of output. The terms of inputs(K) and labour (L).


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MRTS is similar to MRC marginal rate

of substitution in indifference curveanalysis MRTS dimnishes always.


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EQUILIBRIUM OF THE FIRM

CHOICE OF OPTIMAL

COMBINATION OF FACTORS

A producer or a firm is said to be in equilibriumwhen it is able to produce more output with

given outlay and given factors of production. Arational producer may attain equilibrium eitherby maxmising output for a given cost orminimising cost subject to a given level ofoutput. In order to determine the producersequilibrium we should intergrate an isoquant

map with isocost line.


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An isoquant is the locus of all combinations oftwo factors of production that yield same level ofsatisfaction. Isoquant map refers to a group ofisoquants each representing different levels of

output. An isocost line represents variouscombinations of two inputs that may bepurchased for a given amount of expenditure.


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Maximisation of output for a

given cost.

A rational producer will always try to maxmise hisoutput for given cost. This can explained with thehelp of a diagram. Suppose the producers costoutlay is C and the prices of capital and labour

are i and w respectively. Subject to these costconditions the producer would attempt to attainthe maximum output level.


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OPTIMAL FACTOR

COMBINATION TO MAXIMISE

OUTPUT LEVEL.

X

Y

A

BO

IQ1 (1000)

IQ2 (2000)

IQ3 (3000)

Labour

C

A

P

I

T

A

L

E


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Let AB in the figure represents given cost outlay .IQ1,IQ2,IQ3are isoquants representing three different levels of output

IQ3 level of output is not attainable because it is out of reach

of producer .In fact any output level beyond isocost line AB

is not attainable .The producer firm reaches equilibrium

position at point E at this stage he employs OK amount of

capital and OL of labour.

The aim of producer is to maximize his output with given cost

outlay he will prefer only point E and not any other point onisocost line.


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Minimisation of cost for a

given level of output

The producer or the firm may minimize thecost of producing a given amount of output. Inboth the cases the condition of equilibrium

remains the same. That is the MRTS must beequal to factor price ratio.

MRTSLK=w/i=Pl/PkWhere, W=wages (price for labour)

i=interest (price for capital)pl =Price of labour

pk=price of capital


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O L B1 B2 B3 X

LABOUR

Y

A3

A2

A1

K

IQ (2000)

F

G

E

C

A

P

I

T

A

L


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of isocost lines representing various levels of total costoutlay (A1B1, A2B2, A3B3).The isocost lines Here , we have

one isoquant representing given level of output(i.e 2000units) and a set are parallel, and thus have the same scopebecause they have been drawn on the assumption ofconstant price of factors.

The iso-cost line,AB is not relevant because the output level

represent by the iso-quant IQ2(i.e. 2000units) is notproducing by any factor combination F and G on A3B3isocost line. But he can also produce the same level ofoutput at point E (equilibrium) on A2B2isocost line at alower cost. Since the producers aim isto minimize the cost,he will choose the point E rather than F and G becausethese two points lie on the higher cost outlay. Therefore,the producer by employing OK of capital and OL of labourcan reach the equilibrium E by minimizing the cost for astipulated output (2000 units).

EXPANSION PATH (Ch i f i l


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EXPANSION PATH: (Choice of optimal

expansion path)

When the financial resources of a firm increases,it would like to increase its output. The outputcan be increased if there is no increase in thecost of the factors. In other words, the output

produced by a firm increases with increase inits financial resources. By using differentcombinations of factors(inputs) a firm canproduce different levels of output. Amongthese, the combination of factors which is

optimum will be used by the firm and it iscalled as Expantion path. It is also called asscale-line . According to Stonier and HagueExpantion path is that line which reflects leastcost method of producing different levels ofoutput.


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P

e1

e2e3

P

O B D G X

LABOUR

Y

F

C

A

K

IQ3 (3000)IQ2 (2000)

IQ3(1000)


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Units of labour employed is measured along the X axis and capitalemployed is measured along the Y axis. The first iso-cost line of the

firm is AB. It is tangent to IQ at point E, which is the initial equilibrium

of the firm. Supposing the price per unit of labour and capital remains

unchanged and the financial resources of the firm increases, the firms

new iso-cost line shifts to right as CD. In this situation new iso-cost lineCD will be parallel to the initial iso-cost line AB and tangent to IQ2at

point E2which will be the new equilibrium point now. If the financial

resources of the firm further increases, but the price of the factors

remaining the same, the iso-cost line will be FG. It will be tangent to

the iso-quant IQ3 at point E3which will be the new equilibrium point

of the firm. By joining all the equilibrium points we get a line(PP) called

scale-line or expansion path. It is called so because a firm expands its

output or scale of production in conformity with this line.


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COST MINIMISATION

The firm wants to produces any amount

of output at the least cost. This isobtained by point of tangency of theisoquant to an ISO cost line. In other

words, minimum cost mean that

Isoquants are tangents to ISO costlines.


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A

N

ML

B

O X1 D1 D2 D3 X

LABOUR

Y

C3

C2

C1

Y1

C

A

P

I

T

A

L

IQ3

IQ2

IQ3


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In the above diagram the maximum output isobtained at a point of tangency between isoquant

and ISO cost lines. N,M,L are the points of tangency.

The firm expands output along the line D. At the

point of N output, the firm buys OX|and OY|inputs.This is the optimal combination of inputs. At this

point, the marginal rate of substitution between

inputs is equal to the ratio between the prices of the

inputs. The minimum cost represented by the point

of tangency between the isoquant and ISO cost line.,


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Uses of production function

1. To know least-cost combination.

2. To maxmise production.

3. To attain equilibrium.4. Helps in decision making.

5. Basis for production planning.


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Production function one variable input:Short run

analysis(Law of variable proportion)

The law of variable proportion occupies veryimportant place in ME because it examines theproduction function with one variable inputkeeping the other inputs fixed when quantities ofone input is varied keeping other inputs constant

the proportion between fixed factor and variablefactor is altered when combination of inputs arethus altered the resulting output changes .Theeffect of output of variations in factor proportionsis called law of variable proportions.

The law states that as more and more of factorinput is employed all other input quantitiesremaning constant a point will eventually bereached where additional quantities of varyinginput will yeild deminishing contributions to totalproducts .


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Assumptions

1. The state of technology of productionremains unchanged

2. Some inputs are kept fixed during the

process of production.It is only in thisway that factors proportions arealtered to know its effect on output

3. The law is based on the possibility ofvarying proportion in which various

factors can be combined to produce aproduct.


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Illustrations of law

No ofworkers

(x)output(o)

Average

product

o/y

Marginal

Product

Stages

1

23

8

1727

8

8.59

8

910

Increasing

returns-I

4

5

6

7

36

43

48

48

9

8.6

8

6.8

9

7

5

0

Decreasing returns-

II

8 46 5.7 -2 Negative

Returns-II


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From total output average output canbe derived. Marginal product is the

addition to total product which can beproduced by addition of more units ofvariable input. Average output is the

ratio of total output to amount ofvariable input. The behaviour of thetotal average and marginal output is

shown in the diagram.


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Increasing returns stage:

In this stage 1 total product increases at anincreasing rate. Two men produce more than twiceas one man. In this stage both marginal product

(MP) and average product (AP) are rising. BecauseMP is greater than AP MP pulls up the average

product. The boundary line of 1 stage is reachedwhen AP and MP are equal. This takes place at the

point N in the diagram. The first stage is known asthe stage of increasing returns, because the AP ofthe variable factor is increasing throughout the

period.


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Decreasing returns stage

In the stage II,The total product contines toincrease,but at a diminishing rate. When themarginal product is zero,the total product is the

maximum. In this stage both AP & MP aredeclining. MP being below the averageproduct,pulls the agerage product down. At theend of the second stage at the poing M,themarginal product to the variable product inputs

become zero,while the total point reaches theheighest point. This stage is called the stage ofdeminishing returns as both the average andmarginal products of the variable factorcontinuously fall.


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Negative returns stage

In the stage III,total product declines and thereforethe total product curve slopes downword. As aresult,the marginal product is negative and theMP curve goes below OX axis. The averageproduct decreases still further. It shows that the

variable factor is toomuch to mixed factor. Thisstage is called the stage for negative returns.

It may be noted that the stage I and III arecompletely symmetrical. In the stage I,fixed

factor is toomuch relative to the variable factor.In this stage marginal product of the fixed factoris negative. On the other hand,in the stageIII,variable factor is toomuch relative to the fixedfactor. Therefore marginal product of the variableproduct is negative.


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The stage of operationThe question is which stage of operation is rational to production. A

rational producer will not choose to produce in the stage III. At

the end of stage II at the point M,the marginal product and thuswill be making the maximum use of the variable factor. In thestage I,the producer will not be making maximum use of fixedfactor and he will not be utilising fully the opportunities ofincreasing production by increasing the quantity of variableproduct,whose average product continues to raise throughoutthe stage I. Thus a rational producer will not stop in the stage

I,but will expand further. At point N the marginal product to thevariable factor is the maximum and the end point N of the stageI,he will be making maximum use of the fixed factor. So long asthe average product,marginal product and total product areraising,the entrepreneur will not stop producing. Therefore hegoes to stage II,where both marginal product and the averageproduct of the variable factor are deminishing. The stage IIrepresents the range of rational production decisions.


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The laws of returns to scale(Long run)

The laws production describe the technicallypossible ways of increasing the level of

production. These show how the input can beincreased by changing the quantities of factorinputs. In the short run only one factor can bealtered, keeping the other factor unchanged. Itis because ,in the short period, fixed factors

like machinery cannot be altered. But it ispossible to alter the fixed factors in the longperiod. The laws of returns to the scale refersto the long run analysis of production.


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The laws of returns to scale are entairly different from the laws

of variable proportion. In the laws of returns to the scale,all

productive factors or inputs are increased or decreased in the

same proportion simeltaneously. In returns to scale,we analyses

the effect of doubling or tribling,quadrupling and so on of allinputs from the output of the product. The study of changes in

the output as a consequence of changes in the scale,forms the

subject matter of returns to scale.

The three phases of returns to scale


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The three phases of returns to scale

Producers who have not studied economic analysisthink that output can be doubled by doubling all theinputs or trible the output by tribling all theproductive inputs. But actually this is not so. Inother words,actually the output are returns donotincrease/decrease strictly according to the change inthe scale.

If the increase in the output is proportional toincrease in the quantities of input,returns to scaleare said to be constant. It means that a doubling of

inputs causes a doubling of output. If the increase inoutput is more than the proportional,returns to scaleare increasing and if the increase in output is lessthan proportional,returns to scale to scale redeminishing.


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Returns to scale

S.No. Scale of inputs Total

product

Marginal

productorreturns

Stage

1

2

34

1 worker + 3 acres ofland

2 workers + 6 acres ofland

3 workers + 9 acres ofland

4 workers + 12 acres

2

5

914

2

3

45

Increasingreturns-I

5

6

5 worker + 15 acres

6 worker + 18 acres

19

24

5

5

Constantreturns-II

7

8

9

7 worker + 21 acres

8 worker + 24 acres

9 worker + 27 acres

28

31

33

4

3

2

Diminishingreturns-III


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Illustration

In the table,it can be sean that as all the factorinputs are together increased to the same extent,themarginal product or returns increases first up to apoint then constant for some further increase in the

scale and ultimately starts declining. At the s.cale of 1workers +30 acres of land,the total product is 2quintals. To increase the output,the scale isdoubled,the total increases to more than double(5quintals instead of 2 quintals). When the output is

tribled,the output increaes to 9 quintals,the increasethis time being 4 quintals instead of 3 quintals. Inother words,the return to scale is increasing. If thescale of production is further increased,the marginalproduct remains constant upto a certain point andbehyond it,it starts deminishing.

Increasing returns to scale


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Increasing returns to scale

Increasing returns to scale means that output increases in a

great proportion than increase in inputs.If for example allinputs are increased by 25 percent,the output increases by 40percent,then the increasing returns to scale isprevaililng.When the firm is expanding ,increasing returns toscale obtained in the beginning.One chief reason for thisincrease is the effect of technical and managerialindivisibility.Indivisibility means that equipment is available

only in minimum sizes and the firm has to start producingfrom the minimum size of equipment.In the beginning thefirm will not be in a position to use the equipment to itsoptimum capacity.In other words ,the equipments are under-utilized in the beginning.When the scale of operations areincreased,they are input into maximum use and hence the

output are return increases more than proportiionately.


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0 1 2 3 4 5 6 7 8 9 10

Scale

6

5

4

3

2

1

Marginalp

roduct

Stage II

Marginal products or returns


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Constant returns to scale

If the scale of inputs are increased in a given

proportion and the output increases in the sameproportion,returns to scale are said to beconstant,that is doubling of all inputs,doubls theoutput. In mathematics the case of constant returnsto scale is called lenier and homogeneous production

function or homogeneous production function of thefirst degree. In some industries,expansion of outputproduces no net economies are diseconomies and thecost of production remains the same.

Such industries said to be goverened by the law ofconstant returns.

Diminishing returns to scale


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Diminishing returns to scale

When the output increases in smaller proportion thanthe increase in all inputs,decreasing returns to scale is

said to prevail. When firm goes on expanding byincreasing all its inputs,then eventually diminishingreturns to scale occur.economists give different causefor diminishing returns some economists view that theenterpreneur is one fixed,while all other inputs arevariable factors. But the enterpreneur factor cannot beincreased. On this view they say that the law ofdiminishing returns is the special case of the law ofvariable proportions. In this case they say that we getdiminishing returns beyond a point,because varyingquantities of all other inputs are combined with the

enterpreneur as a fixed factor. Other economists do notsubscribe to this view but they say that diminishingreturns to scale occur because of increasing difficultiesof management, coordination and control. When thefirm becomes gigantic, it is difficult to manage it withthe efficiency as before.

Empirical prod ction f nction


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Empirical production function

There are five types of linear andnon-linear models of productionfunctions used in empirical studies.

LINEAR PRODUCTION FUNCTION.

QUADRATIC PRODUCTION FUNCTION.

CUBIC PRODUCTION FUNCTION. POWER PRODUCTION FUNCTION.

COBB DOUGLAS PRODUCTION

FUNCTION.


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Linear production function.

This is the simplest form of productionfunction. In the short run it stated asfollows:

Q=b0+b1V WhereQ= Output

b0=fixed factor input

B1= slope coefficientV = variable factor

Graphically the production function can

be represented by a straight line


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V

AP=MP

Q


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The value of b0 intercept parameter in the

shortrun production function refers to the fixed

factor input quantity b1 the slope coefficient

represents the marginal product (MP) the

variable factor. It being constant alsorepresents the average product (AP). As such

AP=MP when MP is constant, the marginal

and average product curves are horizontalstraight lines, which tend to coincide.


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Quadratic production function

It is stated as followsQ=b0+b1V-b2V

2

This equation measures downward slope of the APand MP curves as shown below. It is useful to know

the quantum diminishing returns.Q

V

AP

MP

Cubic production function


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Cubic production function

It is stated as follows

Q=b0+b1V+b2V2

-b3V3

This function highlights the law of non proportional returns to

the variable factors. Graphically it shows that the marginalproduct(MP) curve is initially raising and then falling. Also

the MP curve intersects the AP curve at its maximum point.


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Power production function

It is stated as follows

Q=aVb

where Q=the output

a=constant parameter

b=power

V=variable factor input

Logarithmically, its linear form is as follows

log(Q) = log(aVb)

log Q = log a + log (Vb)

log Q = log a + b log V

Cobb-Douglas production function


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Cobb-Douglas production function

All the above stated production considered a

single variable factor at a time. The Cobb-Douglas production function considers twovariables factor inputs. The Cobb-Douglasfunctional form of production function is

widely used to represent the relationship ofoutput to inputs. For production thefunction is

Y=ALk

Where Y=Output, L=Labour input, K=Capitalinput

A,, =Constant determined by technology.


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Cobb and Douglas were influenced by statisticalevidence that appeared to show that the labour and


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evidence that appeared to show that the labour andcapital share of output were constant over a periodtime in developed countries they explained this bystatistical fitting least squares regression of theirproduction function. Its transformation into linear formby using logarithms is as follows:

Log A+Log L+Log K.

The common form of Cobb Douglas function used in

Macro economic modeling is Y=KL1- where K is capital and L is labour. When

the model coefficient sum to one as above, theproduction function is first order homogenous, whichimplies returns to scale that is if all the inputs aredoubled the output is doubled.

In the Cobb Douglas function, elasticity of substitutionbetween capital and labour that is capital can beinterchanged with labour without affecting output.

CES PRODUCTION FUNCTION


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CES PRODUCTION FUNCTION

Proposed by American economist Kenneth and Arrow

CES production function is also known as constantelasticity of substitution production function.This is alinear homogenous production function with constantelasticity of input substitution which takes on the formother than unity.

It is replaced the cobb Douglas production functionmodel which looked at physical output as a product oflabour and capital inputs

The equation for CES production function model is

Q=A(aK-b+(1-c)L-b)-1/b

Where Q=output ,K=capital ,L=labour

a,b,c, are constants

PRODUCTION POSSIBLITY


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PRODUCTION POSSIBLITY

CURVE

An economy has a certain population andsome millon workers of various grades, ithas mastered certain techniques ofproduction, it has certain resources in the

form of land, water and other naturalresources.IT has a certain number ofinputs. The society has really to decidehow this resources can be utilised to

produce the various possible commodities.In other words, it has to discover itsproduction possibility curve.

The production possibility curve shows the maximum


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The production possibility curve shows the maximum

output of any one commodity that the economy can

produce together with the prescribed quantities of other

commodities produced and resources utilised.In shortPPT curve tells us what assortment of goods and

services the economy can produce with the resources

and techniques at its disposal. The assortment on the

curve is regarded as technologically efficient and belowit as inefficient. For the simple reason that the

economic is capable of producing a bigger assortment

at least in respect of one commodity without

decreasing any other. Any assortment which is beyond

the frontier is really beyond the economy power and is

unattainable. The PPT curve depicts the societys

menu of choices.

We shall illustrate the concept of PPT curve by means of table


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We shall illustrate the concept of PPT curve by means of table

and a daigram. Let us take two commodities X and Y that a

firm can produce. If it decides to devote more of its resouces to

production X it must sacrifice to that extent production of

Y.Take the following table-

Production

possibilities

X

(Thousands)

Y

(thousands)

A

B

C

D

E

F

0

1

2

3

4

5

15

14

12

9

5

0


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Let all the productive resources available devoted

to the production of Y with the result that 15,000 Y

but no X in between these two extreme limitsthere are numerous combinations of X and Y that

can be produced .The PPT curve can be depicted

by means of diagram given below.In this diagram

A represents the one extreme limit at which all ysare produced now if we want to produce some X

some Y will have to be sacrifice for instance in

order to produce 1000 X we shall have to be

content with 14,000 Y instead of 15,000.We havetransformed 1000 Y into 1000 X and so on down

the table.So, PPT curve is also called as

Production transformation curve.


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Pro

duc

tY(Thousan

ds

)

I th di th k th d ti


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In the diagram, the curve marks the production

possibility frontier and all points on the curve

represent production possibility, the pointsinside the curve are attainable combinations

and those outside such as s, t are unattainable

combinations. Any point inside the curve

represents an under utilisation of resources or

under-employment. A fuller utilisation will shift

the curves outwards. Increase in the resources

at the disposal of the firm will take it to higher

production possibility curve.


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MARGINAL RATE OF TRANSFORMATION

We have seen above that in order to produce moreX we must sacrifice some Y,that is Y can betransformed into X,the rate at which oneproducts is transformed into another is called as

marginal rate of transformation for instancemarginal rate of transformation between good Xand good Y is the amount of Y which has to besacrificed for the production of X .This makes PPCconcave in the origin.The MRT at any point onproduction possibility curve is given by slope ofthe curve at that point.

ECONOMIC REGION


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ECONOMIC REGION

PRODUCTION (RIDGE LINES)

Generally production functions generateisoquants which are convex and negativelysloped, do not intersect each other and

higher the isoquants greater the leveloutput. There are some productionfunctions which yield isoquants having allthe properties except they are not

negatively sloped segments. In otherwords they are positively sloped segments


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LABOUR

CAPITAL


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Let us consider isoquant P3. AB segmentof this isoquant is positively sloped.Similarly other isoquants have the slope.

Beyond points A and B this isoquant ispositively sloped. The points where theybent back upon themselves implying thatthey become positively sloped. The lines

OK and OL joining these points are calledridge lines. They form the boundaries forthe economic region of production.


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Suppose the output represented by isoquant P3 is to beproduced. For producing this quantity a minimum of OK2amount of capital is required because any smaller amountwill not allow the producer to attain the P3 level of output.With OK2 amount OL2 amount of labour must beemployed.In case the producer uses an amount of labour

less than OL2 together with OK2 amount of capital hisoutput level would be lower than the one represented byisoquant P3.This is quite normal because smaller inputswould lead to smaller output.But combining labour input inan amount larger than OL2 with OK2 amount of capitalwould also result in output smaller than represented byisoquant P3.In oder to maintain P3 level output with a

larger amount has to be used. This is something no rationalproducer would attempt to do because it involvesuneconomic use of resources.


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Point B on isoquant P3 represents theintensive margin of labour because anincrease in the labour input beyond OL2

with fixed amount of capital input OK2results in a fall of in the output level. ATthis point marginal product of labour iszero and thus the MRTS of labour for

capital is zero. This implies that at point Blabour has been substituted for capital tothe maximum extent.


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Similarly for producing P3 level of output a minimum of OL1amount labour input in required. A smaller amount oflabour input will not the producer to attain P3 level ofoutput. With OL amount OK1 amount of capital must beused and any additions to capital input beyond OK1 wouldresult in smaller output. Therefore the marginal product ofcapital is zero at point A. This point represents intensivemargin of capital because increase in the amount of capitalinput beyond OK1 with a fixed labour input of OL1willreduce rather than augment output. At point A on P3capital has been substituted for labour to the maximumextent the MRPS of capital for labour is zero which meansMRPS of labour for capital infinite


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The line OK connects the points of zeromarginal product of capital. We havedesignated it as upper ridge line. Similarlythe line OL designated as lower ridge line

joins the points of zero marginal productof labour. The combinations of labour andcapital inputs comprising the areabetween ridge lines OL and OK constitute

the generalized stage2 of production forboth the resources. These combinationsthat are relevant for production decisions.


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Economies of scale

Large scale production is economical in the sense that thecost of production is low. The low cost leads to economiesof scale.

The economies of scale can be divided into two broadcategories as:- a) Internal economies b)External

economies. Internal economies are those economies which occur when

firms size expand. They emerge within the firm itself as itsscale of production increases. Internal economies are thefunction of the size of firm.

External economies are those economies which are sharedby all firms in an industry or group when their sizeexpands. They are available to all firms irrespective of theirsize and scale of production. These economies are thefunction of the size of the industry or group of industries as

whole.


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Forms of internal economies Labour economies.

Technical economies

a)Economies of superior technique

b)Economies of increased dimension.

c)Economies of linked process. Managerial economies.

Marketing economies.

Financial economies

Risk minimizing economies a)By diversification of output.

b)By diversification market.

c)By diversification of sources of supply as well

as process of manufacturing.


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Forms of external economies

Economies of localization.

Economies of information ortechnical and market intelligence.

Economies of vertical disintegration.

Economies of byproducts.

f


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Diseconomies of scale

Difficulties of management.

Difficulties of coordination.

Difficulties in decision making.

Increased risks.

Labour diseconomies.

Scarcity of factor inputs. Financial difficulties.

Marketing difficulties

E i f


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Economies of scope

The concept of economies of scope is oftensomewhat used differently than the concept ofeconomies of scope.

It refers to reduction in unit cost realised when

firm produces two or more products jointly ratherthan seperately.

A multi product firm often experiences economiesof scope. These economies exist when a firm

produces two products together undser the sameproduction facilities as against producing themunder separate facilities. Thus :-

TC(QX,QY)


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ILLUSTRATION A firms total cost function is

TC=200-QX QY +QX2 QY

2

Where QXand QY represent the number of units of product xand y.

Do economies of scope exist when the firm produces 2 units ofx and 4 units of y?

TC(QX

,QY

)


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Degree of economies of scale

The degree of economies of scope can be measured interms of the difference in the cost of production jointly andseparately. The formula is used to measure the degree ofeconomies of scope.

DES=TC(An)+TC (Bn)-TC (An+Bn)/TC(An+Bn)

Where,

DES=degree of economies of scope.

TC(An)=Total cost of producing An units of product Aseparately.

TC(Bn)=Total cost of producing Bn Units of products B

separately. TC(An+Bn)=Total cost of producing products A and B

jointly, that is producing An units of product A and Bn unitsof product B together.

L i


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Learning curve

Experience is the best teacher in business. Over time whenthe firm accumulates its business experience it may tend toimprove its production organization methods withimproved knowledge and experience of management andlabour used in production process.

The firms learning experience would pay in terms of cost ofproduction. In long run these tends to the downward shiftsin the average cost curve of the firm on account of learningexperience effect that improves productive efficiency of thefirm in its operations over a time.

Learning effect is different from scale economy effect. It isthe difference between actual average cost and estimatedeaverage cost. It implies saving in cost .


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Economies of scale are measured through a give LAC as achange in the level of output per time period. The learningeffect rate can be measured by using a formula:-

LER=[1-ACt1/ACt0]*100

Where ,

LER=learning effect rate.

ACt0=average cost in initial period (t0) increment.

ACt1 =average cost in next period(t1) increment.

Incidentally the ratio ACt1/ ACt0 is referred to as

experience factor.

X ffi i


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X efficiency

Cost economy is the major goal of a business firm.Efficiency in production implies cost economy. An efficientfirm will tend to experience lower cost function. When theefficiency improves cost function of the firm tends to shiftdownwards.

In practice a major way of cost reduction is seen throughminimization of the wastage of resources. More wastageimplies higher cost. Low wastage means low cost.

X efficiency is a function of management to reduce andminimize the waste of resources in operations. New

approaches such as Six Sigma methodology are essentiallymeant towards attainment of X efficiency (wasteminimization as well as zero defect level) of business firm.

51633013 the Production Process Ppt

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