This document provides an overview of production theory and costs. It defines production as the process of converting inputs into outputs. The relationship between inputs and outputs is represented by the production function. There are laws of variable proportions that describe how average and marginal productivity change with increasing input usage in the short-run. In the long-run, returns to scale can be increasing, constant, or decreasing. The document also defines different types of costs including fixed, variable, average, and marginal costs and how they change with output levels in the short-run.

1. BABARIA INSTITUTE OF TECHNOLOGY
SHREE KRISHNA EDUCATIONAL CHARITABLE TRUST
Approved by AICTE, NEW DELHI, Affiliated to GTU
PREPARED BY:
1.SAURABH DAYAL SINGH
2.KARNIKA
3.VAIBHAV
4.VISHAL
5.ASTHA
SUBJECT : ENGINEERING ECONOMICS AND MANAGEMENT
SUB.CODE : 2130004
BRANCH : ELECTRICAL
SEMESTER : 03

2. Theory of Production

3. Theory of Production
• Production is a process that create/adds value
or utility
• It is the process in which the inputs are
converted in to outputs.

4. Production Function
• Production function means the functional relationship
between inputs and outputs in the process of production.
• It is a technical relation which connects factors inputs used
in the production function and the level of outputs
Q = f (Land, Labour, Capital, Organization, Technology, etc)

5. Production Function
• Production refers to the transformation of inputs or resources into
outputs of goods and services. In other words, production refers to all of
the activities involved in the production of goods and services, from
borrowing to set up or expand production facilities, to hiring workers,
purchasing row materials, running quality control, cost accounting, and so
on, rather than referring merely to the physical transformation of inputs
into outputs of goods and services.
• FOR EXAMPLE
1. A computer company hires workers to use machinery, parts, and raw
materials in factories to produce personal computers.
2. The output of a firm can either be a final commodity or an intermediate
product such as computer and semiconductor respectively.
3. The output can also be a service rather than a good such as education,
medicine, banking etc.

6. Factors of Production

7. Inputs : Fixed inputs and Variable inputs
The factors of production that is carry out the
production is called inputs.
Land, Labour, Capital, Organizer, Technology, are
the example of inputs
Inputs Factors
Variable inputs Fixed Inputs

8. Inputs : Fixed inputs and Variable inputs
Fixed inputs
 Remain the same in the short
period .
 At any level of out put, the
amount is remain the same.
 The cost of these inputs are
called Fixed Cost
 Examples:- Building, Land etc
 ( In the long run fixed inputs are
become varies)
Variable inputs
 In the long run all factors of
production are varies
according to the volume of
outputs.
 The cost of variable inputs is
called Variable Cost
 Example:- Raw materials,
labour, etc

9. Various concept of production
Total product (total physical product) = the total amount of output
produced, in physical units .
Average product (AP) – total output divided by total units of input,
means production per unit of input.
Marginal product – the extra product or output added by 1 extra
unit of that input while other inputs are held constant.
L
TP
AP =
L
TP
MP
∆
∆
=

10. Production with One Variable Input
Labour
(L)
Capital
(K)
Total
Output
(TP)
Average
Product (AP)
0
1
2
3
4
5
6
7
8
9
10
10
10
10
10
10
10
10
10
10
10
10
Marginal Product
(MP)
0
10
30
60
80
95
108
112
112
108
100
Short run Production Function with Labour as Variable factor

11. Production with One Variable Input
Labour
(L)
Capital
(K)
Total
Output
(TP)
Average
Product
(AP)
0
1
2
3
4
5
6
7
8
9
10
10
10
10
10
10
10
10
10
10
10
10
0
10
30
60
80
95
108
112
112
108
100
10
20
30
20
15
13
4
0
-4
-8
-
10
15
20
20
19
18
16
14
12
10
Marginal
Product
(MP)
Short run Production Function with Labour as Variable factor

12. A
C
B
Total Product
Labor per month
3
4 8
84
3
E
Average product
Marginal product
Output per
month
112
Labor per month
60
30
20
10
D

13. Law of Production Function
 Laws of Variable proportion- Law of
Diminishing Return ( Short run production
function with at least one input is variable) .
 Laws of Return scales – Long run production
function with all inputs factors are variable.

14. Law of variable proportion:
Short run Production Function
• Production function with at least one variable factor
keeping the quantities of others inputs as a Fixed.
• Show the input-out put relation when one inputs is
variable .
“If one of the variable factor of production used more and more
unit,keeping other inputs fixed, the total product(TP) will
increase at an increase rate in the first stage, and in the
second stage TP continuously increase but at diminishing
rate and eventually TP decrease.”

15. Production with One Variable Input
Labour
(L)
Capital
(K)
Total
Output
(TP)
Average
Product
(AP)
0
1
2
3
4
5
6
7
8
9
10
10
10
10
10
10
10
10
10
10
10
10
0
10
30
60
80
95
108
112
112
108
100
10
20
30
20
15
13
4
0
-4
-8
-
10
15
20
20
19
18
16
14
12
10
Marginal
Product
(MP)
10
10
10
10
10
10
10
10
10
10
10
Land
First Stage
Second Stage
Third Stage
Short run Production Function with Labour as Variable factor

16. A
C
B
Total Product
Labor per month
3
4 8
8
4
3
E
Average product
Marginal product
Output per
month
112
Labor per month
60
30
20
10
D
First Stage
Second Stage
Third Stage

17. Stages in Law of variable proportion
First Stage: Increasing return
 TP increase at increasing rate till the end of the stage.
 AP also increase and reaches at highest point at the end of the stage.
 MP also increase at it become equal to AP at the end of the stage.
 MP>AP
Second Stage: Diminishing return
 TP increase but at diminishing rate and it reach at highest at the end of the
stage.
 AP and MP are decreasing but both are positive.
 MP become zero when TP is at Maximum, at the end of the stage
 MP<AP.
Third Stage: Negative return
 TP decrease and TP Curve slopes downward
 As TP is decrease MP is negative. AP is decreasing but positive.

18. Law of return to scales
Long run Production Function
• Long run production function when the inputs are changed in
the same proportion.
• Production function with all factors of productions are variable.
• Show the input-out put relation in the long run with all inputs
are variable.
“Return to scale refers to the relationship between changes of
outputs and proportionate changes in the in all factors of
production ”

19. Law of return to scales: Long run Production Function
Labour Capital TP MP
2 1 8 8
4 2 18 10
6 3 30 12
8 4 40 10
10 5 50 10
12 6 60 10
14 7 68 8
16 8 74 6
18 9 78 4
Increasing returns to scale
Constant returns to scale
Decreasing returns to scale

20. 1. Law of return to scales: Long run Production Function
Increasing returns to scale
Constant returns to scale
Decreasing returns to scale
Inputs 10% increase – Outputs 15% increase
Inputs 10% increase – Outputs 10% increase
Inputs 10% increase – Outputs 5% increase

21. Homogeneous production function
In the long run all inputs are variable. The production
function is homogeneous if all inputs factors are
increased in the same proportions in order to change
the outputs.
A Production function Q = f (L, K )
An increase in Q> Q^ =f (L+L.10%, K+K.10% )- Inputs increased same proportion
Increasing returns to scale
Constant returns to scale
Decreasing returns to scale
Inputs increased 10% => output increased 15%
Inputs increased 10% => output increased 10%
Inputs increased 10% => output increased 8%

22. Linearly Homogeneous production function
In the long run all inputs are variable. The production function is
Linearly homogeneous if all inputs factors are increased in the
same proportions and the output is increased in the same
proportion.
Constant returns to scale Homogeneous production function
Inputs increased 10% => output % increased 10
A Linearly homogeneous Production function Q = f (L, K )
if labour and capital increased 10% then output increased the same 10%

23. Linearly Homogeneous production function
A Linearly homogeneous Production function Q = f (L, K )
if labour and capital increased 10% then output increased the same 10%
100 unit output
200 unit output
300 unit output
400 unit output
%changes in factor Labour
%changes in factor
Capital

24. Iosquants
Combination Labour Capital Output level
A 20 1 100 unit
B 18 2 100 unit
C 12 3 100 unit
D 9 4 100 unit
E 6 5 100 unit
F 4 6 100 unit
An isoquants represent all those possible combination of two inputs (labour
and capital), which is capable to produce an equal level of output .

25. 100 unit output
Labour
Capital
Isoquants or equal product curve
Iosquants
An isoquants represent all those possible combination of two inputs
( Labour and Capital ), which is capable to produce an equal level of
output.

26. 100 unit output
Labour
Capital
Isoquants or equal product curve
Marginal Rate Technical Substitute(MRTS)
The slop of isoquant is known as Marginal Rate of Technical Substitution (MRTS). It is the rate at
which one factors of production is substitute with other factor so that the level of the out put
remain the same.
MRTS = Changes in Labour / changes in capital

27. COST

28. Definitions of Costs
• It is the firm of the individual operating in a
marketing has a influence on the market
supply of the commodity.
• In order to make use of the various factor and
non-factor inputs.
• In common, the amount spend on these
inputs is called the cost of production.

29. Concept Of Cost
• MONEY COST :
The amount spend in terms of money for the
production of the commodity is known as money
cost .
• NOMINAL COST:
It is the money cost of production.
• REAL COST :
It is the mental and physical and sacrifices
undergone with a view to producing a
commodity.

30. •OPPORTUNITY COST :
The real concept of production of given commodity is the next best
alternative sacrificed in order to obtain that commodity.
•SUNK COST :
•Firm buys a piece of equipment that cannot be converted to
another use
•Expenditure on the equipment is a sunk cost
•Has no alternative use so cost cannot be recovered – opportunity
cost is zero
•Decision to buy the equipment might have been good or bad, but
now does not matter

31. •IMPLICIT COST :
It is the cost of self-owned resources such as salary of proprietor.
•EXPLICIT COST :
* It is the paid-out cost.
* It means payments made for the productive resources purchased.
• ACCOUNTING OR BUSINESS COST:
Cash payments which firms make for factor and non-factor input
depreciation other book keeping entries.
• SOCIAL COST:
It is the amount of cost the society bears due to industrialization.
•ENTREPRENEUR’S COST:
The cost of production in the sense of money cost or expenses of
production.

32. •ACCOUNTING COSTS: These are the actual or outlay costs. These costs point
out how much expenditure has already been incurred on a particular process
or on production as such.
•ECONOMIC COSTS: These costs relate to future. They are in the nature of the
incremental costs.
•DIRECT COSTS: Are the costs that have direct relationship with a unit of
operation like a product, process or a department of the firm. Ex. Variable cost
•INDIRECT COSTS: Are those whose source cannot be easily and definitely
traced to a plant, a product, a process or a department. Ex. Fixed cost
•CONTROLLABLE COSTS: Are those which are capable of being controlled or
regulated by executive vigilance and therefore, can be used for assessing
executive efficiency.
•NON-CONTROLLABLE COSTS: Are those which cannot be subjected to
administrative control and supervision.

33. SHORT-RUN COSTS
In the short run at least one factor of production is fixed.
Output can be varied only by adding more variable factors.
FIXED COST:
Remains constant.
Also known as short-run cost.
This cost includes: *Cost on managerial staff.
*Expenditure on depreciation.
*Maintenance cost of the factory.
VARIABLE COST:
Vary directly with the level of output
Used in the actual production process.
Functions of output changes.
Eg: Cost of raw-materials. Cost in direct labour.
TOTAL COST: Sum of total fixed cost and total variable cost.
TC=TVC+TFC.
TVC=0, when the output is zero and increases with increase in the output.

34. AVERAGE COST
They are of three types.
AVERAGE FIXED COST: It is the per-unit cost of the fixed factors.
AFC=TFC/Q.
AVERAGE VARIABLE COST: It is the per-unit cost of the variable factors.
AVC=TVC/Q.
AVERAGE TOTAL COST:
* It is the total cost divided by the number of units produced.
* Sum of average fixed cost and average variable cost.
ATC=TC/Q
AC=AFC+AVC.

35. CHANGE IN VARIABLE COST

36. CHANGE IN FIXED COST-NO EFFECT

37. MARGINAL COST:
Change in the total cost resulting from the
unit change in the quantity produced.
MC=Change in Q/Change in TC.

38. SHORT RUN COSTS OF PRODUCTION

39. It is a period of time during which the quantities of all factors,
variable as well as fixed can be adjusted.
LONG-RUN AVERAGE COST CURVE:
Slopes downwards.
 Larger scope of specialization of labour.
 Increasing use of specialized machinery.
 Other technological management.
LONG-RUN MARGINAL COST CURVE:
Cuts the LRAC at the lowest point.
It is equal to the LRAC when LAC is neither rising nor falling.
LONG-RUN COST CURVES

40. LONG-RUN COST CURVES

41. The makeup of total cost in the
short and long run

42.  From the law of variable proportions, theory of
production and theory of cost it may not be understood that
there is no hope for raising the standard of living of mankind.
The fact, however, is that we can suspend the operation of
diminishing returns by continually improving the technique
of production through the progress in science and
technology.
CONCLUSION

43. REFRENCES
• www.wikipedia.com
• www.slideshares.com
• www.microeconomics.com
• Adhikary, M (1987), Managerial Economics (Chapter V),
Khosla, Publishing House, Delhi.
• T.S Grewal, Introductory Microeconomics
• Introduction To Microeconomics, CBSE class XII

44. THE END