Production: Production is the transformation of inputs(land, labour, capital, raw materials, etc) into output.
Production Function: Production function is the technological relationship between inputs and output in physical terms. It specifies the maximum quantity of a commodity that can be produced per unit of time with given quantities of inputs and technology. A production function may take the form of a schedule, a graphical line or curve, an algebraic equation or a mathematical model. The general form a production function may be algebraically expressed as:
Q = f(K,L)
Where Q = the quantity of output produced per time unit
K = capital, and
L = labour.
Isoquant: The term ‘isoquant’ has been derived from iso meaning ‘equal’ and quant meaning ‘quantity’. The ‘isoquant curve’ is therefore also known as ‘Equal Product Curve’ or ‘Production indifference curve’. An isoquant curve is the locus of points representing the various combinations of two factors – capital and labour, which yield the same output.
Properties of Isoquants: The properties of isoquants are:
- Isoquants have negative slope. This implies that if one of the factor is reduced the other factor has to be increased so that output remain the same.
- Isoquants are convex to the origin. This implies that the Marginal Rate of Technical Substitution (MRTS) of one factor for another is diminishing.
- Isoquants cannot intersect or be tangent to each other. If isoquants intersect or are tangent to each other it would mean that the same output can be produced with smaller factor combination as well as with larger factor combination which is absurd.
- Upper isoquants represent higher level of output.
Marginal Rate of Technical Substitution (MRTS): The marginal rate of technical substitution (MRTS) is the rate at which one factor can be substituted for another without changing the level of output. This rate of factor substitution is represented by the slope of the isoquant. Therefore,
MRTS = ?K/?L = slope of the isoquant
Or MRTSLK = MPL/MPK
Thus, MRTS of labour for capital is the ratio of the marginal product of labour (MPL) to the marginal product of capital (MPK).
Fixed and Variable Inputs : In economic sense, a fixed input is one whose supply is inelastic in the short run, e.g., plant, machinery, building, etc. In technical sense, a fixed factor is one that remains fixed for a certain level of output.
A variable input is one whose supply is elastic in the short run, e.g., labour, raw material, etc. Technically, a variable input is one that changes with the change in output. In the long run, all inputs are variable.
Short-Run and Long-Run: The short run refers to a period of time in which the supply of certain inputs e.g., plant, building, machinery, etc. is fixed or inelastic. In the short run therefore, production of a commodity can be increased by increasing the use of only variable inputs like labour and raw materials. The long run refers to a period of time in which the supply of all the inputs is elastic, but not enough to permit a change in technology. That is, in the long run, all the inputs are variable. Therefore, in the long run, output can be increased by employing more of both variable and fixed inputs.
Law of Variable Proportions: The law of variable proportions states that as the quantity of one factor is increased, keeping the other factors fixed, the marginal product of that factor will eventually decline. This means that upto the use of a certain amount of variable factor, marginal product of the factor may increase and after a certain stage it starts diminishing. When the variable factor becomes relatively abundant, the marginal product may become negative.
Returns to Scale: Returns to scale refer to the change in output when all factors are increased in the same proportion in the long run. Returns to scale may be constant, increasing or decreasing. If we increase all factors (i.e., scale) in a given proportion and output increases in the same proportion, returns to scale are said to be constant. But if increase in all factors leads to a more than proportionate increase in output, returns to scale are said to be increasing. On the other hand, if increase in all factors leads to a less than proportionate increase in output, returns to scale are decreasing.
Economies of Scale: Economies of scale are the advantages that arise due to the expansion of the scale of production and lead to a fall in the cost of production. There are two types of economies of scale, (a) internal economies and (b) external economies.
Internal economies are those economies or advantages which arise within a particular firm on account of the expansion of its size. They are exclusive and internal to a firm i.e. they arise within the firm. On the other hand, external economies are those economies or advantages which arise from the expansion of the industry as a whole. They are external to individual firms and are equally available to all firms in the industry.
Expansion Path: The expansion path shows how the entrepreneur will change his factor combination as he expands his outputs, given the factor prices. The expansion path represents minimum cost combinations for various levels of output, it shows the cheapest way of producing each output, given the relative prices of factors. Thus, if both factors are variable and the prices of factors are given, a rational entrpreneur will choose to produce at some point on the expansion path.
The expansion path can have different shapes and slopes depending on the relative prices of factors and the shape of the isoquants. When the production function exhibits constant returns to scale, the expansion path will be a straight line through the origin.