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||Theory of Production - Summary Notes ||
1. Production
Input Process Output (have want
satisfying power)
Output Includes both goods & services
Production does not include non-economic
activities
Production does not mean creation of matter – production means creation or
addition of utility.
Utility
Service/ personal
Form utility Place utility Time utility
utility
Changing the form Making available Making available Making available
of goods from RM goods at place goods at times personal services
to finished goods where required when not available to customers
2. Factor of production – land
Free gift of nature
All resources available free of cost on the surface, below
the surface and above the surface.
Supply – Fixed – perfectly inelastic (economy’s point) elastic (firm’s point)
Indestructible, passive factor, place immobility, occupational mobility,
heterogeneous.
3. Labour: Human efforts (mental + physical) for money. Live factor,
highly perishable, active factor, inseparable from labourer,
heterogeneous, weak bargaining power, mobile factor, backward
bending supply curve, no reserve price.
4. Capital:
Produced means of production
Part of wealth used for further production of
wealth
Secondary factor, elastic, perfectly mobile factor.
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Types of Capital
Real vs Human Individual vs Social Fixed vs Circulating Tangible vs
Intangible
Physical Human Personal Belongs Use for Used only Can be Can’t be
Goods Skills/ Property To Long Once in Seen & Seen &
Training Society Time Production Touched Touched
Stages of Capital formation
- Stage I - Creation of savings depends upon Ability to save + willingness
to save
Creation of Savings
Ability Willingness
Income Propensity to Individual Government
consume
Personal Social Compulsory Voluntary
Behaviour setup Savings savings
As Y consumption , savings , propensity to consume propensity to save
[higher savings in developed countries]
- Stage II - Mobilisation of savings - through institution + Govt. role
- Stage III - Investment of savings – done by entrepreneurs
5. Entrepreneur – Organiser, manager & risk bearer
Objectives Organic + economic + social + human +
National
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Function of Entrepreneur
Resource Risk & Uncertainty Innovations
coordination Bearing
Risk – foreseeable &
Collection of factors of insurable Schumpeter considers
production & initiation Uncertainty – innovation as true
of business. unforeseeable & non- function.
Reward of entrepreneur insurable Innovation means any
is uncertain, can be A/c to Frank Knight – new idea or better
positive or negative. Rewarded for bearing technique.
risk not uncertainty.
6.
Product
TP AP MP
Additional
Total production Output per unit
productivity of 1
from all inputs of variable inputs
variable factors
TP = MP AP = TP MP = TPn – TPn-1
TP = AP x n n or TP/ n
7. Production function
- Technical relationship between inputs & outputs
- States maximum output from given input
- Or minimum input required for maximum output
Input
Output = f (input) Combination
8.
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Production function
Short run Long Run
Some variable and All variable
some fixed factors factors
Law of variable Law of return
proportion to scale
9. Law of variable proportions (Law of diminishing returns/ law of returns to factor)
– as we use more inputs additional production initially increases and then falls.
- As input se MP TP se (sing rate)
- MP becomes maximum (TP changes
Y
its curve) (Point of Inflexion)
- MP falls TP se (sing rate)
Point of H
- MP zero TP maximum (TP is
Inflexion
constant) F
Output
TP
- MP –ve TP falls (TP at negative Stage Stage Stage
I II III
rate) S
- AP MP > AP AP
- AP maximum MP = AP N M
X
- AP MP < AP MP
Variable Factor
At 1st level of production TP = MP = AP
Stages
I Increasing returns to factors Ends when AP Maximum (AP = MP)
Reason: full utilisation of fixed factors and specialisation of variable factors
II Diminishing returns to factors ends when TP maximum & MP is zero
Reason: overutilization of fixed factors and imperfect substitutability of factors
III Negative returns to factor when MP negative or TP falls
I & III stages stage of Economic non sense/ economic absurdity
Stage II Stage of operation
Assumption:
- 1 variable, all other fixed factor
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- Technology same
- Homogenous variable factors
- Proportion of fixed & variable factors changes
- Cost is not considered
- Short run
9. Law of returns to scale
Assumption
- All factors variable
- Long run
- Proportion of factor do not change
10.
Returns to scale
Increasing Constant Diminishing
% in output > % in output = % in output <
% in input % in input % in input
Due to economies Due to Diseconomies
Linear
(benefits) of large Homogeneous (Limitations) of large
scale scale
production function
Internal External Internal External
Available to Available to all Disadvantages to
Disadvantages to
particular firm firms in industry particular firm
all firms (when
(when firm (when industry (when firm
industry expands)
expands) expands) expands)
Internal economies
- Purchase of superior techniques
- Management specialisation & mechanisation
- High discounts because of bulk purchases
- Benefits of selling large units
- Easy finance
- Diversification benefits
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External economies
- Cheaper raw material available to all firms
- Advanced technologies development which is available for all firms
- Easy availability of skilled labours due to colleges
- Improved transportation facilities
- Localisation
Internal diseconomies
- High maintenance cost of heavy machines
- Communication gaps, politics, red tapism due to large no. of departments
& hierarchy
- High cost of external finance
External diseconomies
- High cost of natural raw material due to increased demand due to rise
in no. of firms
- Infrastructural strain (e.g. traffic)
- Rise in factor (labour) price due to increased demand
- High advertisement cost due to competition
11. Cobb – Douglas production function
Production function of US based manufacturing industries
Applicable in long run
Assume constant returns to scale
2 factors – Labour & Capital
Contribution – ¾, ¼
Q = ALaKb
If a+b = 1 Constant returns to scale
a+b > 1 increasing returns to scale
a+b < 1 decreasing returns to scale
12. Production optimisation
Isoquants
Similar to IC of consumer behaviour
(equal product curves, production indifference curves, isoproduct curves)
- Set of combination of 2 inputs which give same level of output
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- Same output curve
- Negatively sloped
- Slope is MRTS (which if falling)
- Convex to origin
IQ 100
- Higher IQ depicts higher production
- Output can be measured
Iso cost
Similar to Budget line of consumer behaviour
- Set of combination of 2 inputs which can be purchased
with given outlay
- same cost curve ISO Cost
- Slope is ratio of price of 2 factors – constant – straight
line downward sloping
Production Optimisation
- Given output - Given Input
- Find minimum cost - Find maximum output
E
E
IQ 100
Equilibrium
- Tangency point
- Slope of isoquant = slope of
isocost
- MRTSXY = Px
Py
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