1. Production Analysis
Production is transformation activity that connects factor inputs
and outputs. For example, a farmer uses land, labor and seeds as inputs
to transform them into corn. An input refers to any good or service that
assists in producing an output. A good or service may be input for one
firm, but may be output for another. For example, steel is an input for an
automobile manufacturer, but output for a steel producer.
The process of transformation of inputs to outputs can be
transformed in any of following three ways:
1} Change in form: E.g. transformation of raw materials into finished
goods.
2} Change in place: E.g. transportation
3} Change in Time: E.g. storage

2. Production Function
Production function deals with the maximum output that can be produced with
a limited and given quantity of inputs.
For example, the production function of a steel firm takes into
consideration, various inputs like labor, raw material, power consumption, cost of
land, etc. It also takes into account the quantity of output that is being produced, using all
the above fixed and variable inputs. Thus, production function deals with input as well as
output. A production function can be expressed as an equation, table, or a graph.
If a firm uses inputs like labor (L) and capital (K), then the production function can be
formed as
Q = f (K, L)
Production function has no focus towards the least cost combination or the
profit maximization.
If the firm fails to utilize the available resources effectively, it may not be able to
survive in the long run. Firms using the efficient production processes enjoy minimum
cost but earn maximum profits.
Example:
The production function of a steel company can have inputs like cost of
procuring the ore, power charges, labor charges, etc. Whereas the production function of
a tour operator can be cost of fuel, vehicle maintenance charges, wages and salaries of
employees

3. Factors
Factors that are used for production are called factors of
production. There are four important factors of production. They are –
Land
Labor
Capital
Entrepreneurship
The prices of these factors are rent, wage, interest and profit
respectively.
Factor of Production Price
Land Rent
Labor Wage
Capital Interest
Entrepreneurship Profits

4. Concepts of Product
There are three types of product concepts that are crucial to the
production function.
Total product
Marginal product and
Average product.

5. Total Product, Average Product and Marginal
Product
Total product
The amount of output produced using a given quantity of inputs is
known as total output. As the input increases, the total output also increases. For
example, for a firm producing leather shoes, as the number of labor and the raw
material is increased, output also increases. When the firm is using just a single
labor the firm produces 2,000 units of shoes. On increasing the labor to three, the
total output rises to 3,000.
It can be observed that total product increases with the increase in the
output, and rate of increase starts decreasing after reaching a point, which it can
be observed in the TP graph as well. It can be seen in the graph that the total
product rises by smaller and smaller increments as additional units of labor are
added. TP curve rises initially and starts declining after reaching a point.

6. Average product
Average product can be defined as the total product per unit of factor
employed in the production process. In the given example, average product is 2000
with one labor, every additional labor has resulted in the fall in the average product.
Marginal product
Marginal product can be defined as the extra product or output added by one extra
unit of that input while other inputs are held constant. In the given example, it can
be seen that the first labor can produce 2000 units of shoes alone, i.e. the marginal
product of the first labor is 2000. On adding one more unit of labor, total product
increases to 3,000, resulting in decline in the marginal product. With addition of
each labor unit, marginal product keeps declining. When the 6th labor unit is added,
marginal product becomes negative.
Marginal product helps in determining the wages of the labor. Based on the
marginal product, the firm can arrive at the cost and output relationship of each
additional labor. The concept of marginal product also helps a firm to allocate the
scarce resources of the firm. For example, in the given case a firm could have
avoided adding the 6th labor, as it is resulting in the fall of total product itself.

7. The Three Stages of Production
Based on the law of diminishing returns, Prof. Cassels proposed three
stages in the production process.
Stage I: Stage I offers increasing average returns to the factor of
production, i.e. (Q/L)/ðL > 0 or MPL > APL. Thus, in stage I, average
product increases and the marginal product is greater than the
average product.
Stage II: In stage II, the average product decreases and so does the
marginal product. But marginal product remains positive. This stage
may be called the stage of decreasing returns.
Stage III: In stage III, total product decreases and the marginal
product becomes negative.

8. The Three Stages of Production

9. Points to Remember
When MP = AP, AP will be maximum
When MP = 0, TP will be maximum
Stages of Marginal Returns
Increasing marginal returns: From the starting point of MP
until MP reaches its maximum point.
Diminishing marginal returns: From the maximum point of
MP until MP = 0.
Negative marginal returns: From the point where MP = 0

10. Short Run and Long Run
Time period can be classified into short run and long
run based on the nature of factors of production.
Short run refers to a period of production where all factors of
production are not variable. The period defers from industry
to industry, country-to-country, and firm-to-firm, etc.
Example:
Matchbox industry : 1 day
Soap industry : one year
Shipbuilding industry : 10 years
Long run refers to a period of production where all factors of
production are variable.

11. Products Costs in the Short Run
(Law of Diminishing Returns)
In the short run, the shape of the total product (TP) curve is determined
by the law of diminishing returns. Law of Diminishing Returns (also known
as Law of Variable Proportions) states that given the state of technology, if
we go on employing more of one factor of production, other things
remaining the same, its marginal productivity will diminish after some
point.
Assumption
Law of diminishing returns is based on the following assumptions.
State of technology is constant.
One factor of production must always be fixed. Thus, this law is not
applicable when all the factor inputs are variable.
This law is not applicable when the two inputs are used in a fixed
proportion. This amounts to say that the law is applicable only to varying
ratios between the two inputs.

12. Product Costs in Long Run
Law of diminishing returns is operational only in short run because of its
assumption of one fixed factor input. But in the long run all the factor inputs are
variable.
Law of Returns to Scale: It refers to the long run analysis of production.
According to the law, the long run output can be increased by changing all the factors
in the same proportion, or by different proportions.
As all factor inputs are variable in the long run, the production function is
given by
Q = f (K, L)
The returns to scale may be of three types –
Constant returns to scale
Decreasing returns to scale
Increasing returns to scale

13. Types of Returns to Scale
a.Constant Returns to Scale: If the proportionate change in output
is same as the proportionate change in input, then we say that there
are constant returns to scale (CRS). Symbolically,
CRS: % ΔQ = %ΔI
b.Decreasing Returns to Scale: If the proportionate change in
output is less than the proportionate change in input, then we say that
there are decreasing returns to scale (DRS).
DRS: %ΔQ < %ΔI
c.Increasing Returns to Scale: If the proportionate change in output
is more than the proportionate change in input, then we say that there
are increasing returns to scale (IRS).
IRS: %ΔQ > %ΔI

14. Returns to Scale
Returns to scale show the responsiveness of total product when all the
inputs are increased proportionately. Returns to scale is a factor that is studied
in the long run. Returns to scale can be constant, increasing or decreasing.
Constant returns to scale:
In this case, the change in inputs results in proportional change in output.
For example, if a firm is using three factors of production, land, labor and
capital, and if it doubles all these inputs, output should also be doubled.

15. Increasing returns to scale:
When rise in inputs result in more than proportional increase in the output,
it is known as increasing returns to scale.
For example, if a plant is producing 100 units of the product using 10 units
of labor and 100 units of capital. If the labor is doubled to 20 units and
capital is also doubled to 200 units, and the output generated is 250 units,
then the firm is operating at increasing returns to scale level.
Decreasing returns to scale:
When increase in all the inputs result in less than proportional increase in
output, then it is known as decreasing returns to scale.
For example, if a firm increases all its inputs by 20 percent and the resulting
increase in the output is just 15 percent, then it is the case of decreasing
returns to scale.

16. The Production Isoquant
If a firm is having two variable inputs, the approach to determine the
optimal input rates is completely different. In this scenario, the problem of efficient
resource allocation can be solved in two ways.
Maximize the production, utilizing the available resources. These two
problems are known as constrained optimization problems. The problem of
resource allocation can also be solved by producing the profit maximizing output.
Isoquants also known as production-indifference curves, represent the
combinations of inputs that produce same quantity of output. This can be explained
with the help of an example,
Factor
Labor Capital
Combinations
A 2 24
B 4 16
C 6 10
D 8 6
E 10 4

17. Characteristics of an Isoquant Curve
The properties of an isoquant are similar to that of an
indifference curve.
The following are the important properties of an isoquant
curve.
1) Isoquant curve will be downward sloping: The level of
output is same along the isoquant curve. Thus, if a firm uses
more of one input, it must use less of another input to attain
the same level of output.
2) An isoquant curve is convex to the origin:
3) Two isoquant curves cannot intersect each other. Like
indifference curves isoquant curves too do not intersect each
other.
4) Isoquant Map: A higher isoquant curve gives higher
level of output

18. Convexity
The slope of the isoquant curve measures the marginal rate of technical
substitution (MRTS) as it shows the rate at which one input can be substituted
with another. The slope of isoquant curve diminishes or becomes flatter as we
move from point j to m. This implies that we can substitute lesser and lesser
amount of K for L as we move down the curve. This is because of the operation of
law of diminishing returns.

19. Isoquant Map
In the figure, each isoquant curve reflects a difference level of output. As we
move from the original, each successive isoquant curve reflects a higher level
of output. This is because at a higher isoquant curve we use more of both L and
K, which means more output.

20. Expansion Path
We know that a rational firm, to maximize its output
subject to cost constraint, employs factor inputs in a proportion
such that marginal rate of technical substitution (MRTS) is equal
to factor price ratio.
Given the factor prices, we can get a number of parallel
isocost lines by varying the cost constraint. Each isocost line is
tangent to one isoquant curve. The locus of all such points of
tangencies between the isoquants and isocost lines forms the
expansion path of the firm. The points on the expansion path are
the most efficient combinations of the two inputs.
As all factors of production are variable in the long run,
the firm moves along the expansion path to expand its level of
output, given the factor prices.