Theory of Production

Dr. Qazi Subhan

Production Theory
Production theory describes efficient
combinations of inputs (L,K) which contribute
maximum output (Q) or with least cost
combination.

The firm’s production function relates its

output Q to labor L, capital K, and other inputs
and its production function can be explained as
follows.
Q=f (K,L)
Types of Production Function
There are two types with respect to time
Short Run Production Function
It is that production function in which one input is
fixed (K) and other is variable (L)

Long Run Production Function

It is that production function in which both inputs
(K) and (L) are variable
Types of Production function with respect to
category

Simple Production Function

Cobb- Douglas Production Function

CES ( Constant Elasticity of Substitution)

Production Function
Simple and Cobb- Douglas production
functions
It means that production
function in which there is
no effect of efficiency of Q  f ( K , L, R , S ,  ,  )
inputs and no effect of
technology has been
introduced.

In Cobb Douglas both

parameters have been
taken Care. Q  A * L K 
CES Production Function
That production function in which the elasticity of
substitution remains constant.

Q   K  
 1    L 
 1


 is an efficiency parameter and Sigma is a distribution

parameter that permits the relative importance of K and L.
The Row is the substitution parameter. The closer the value
of row to 1 The higher the elasticity of Substitution.

Lecture 7, Chapter 7
Average and Marginal Product of
Labor
Table 1 includes two derived production concepts
where K=8.
Definition
The marginal product of labor is defined as
Q
(1) MPL 
L
Definition
The average product of labor is defined as

Q
( 2) APL 
L
Lecture 7, Chapter 7
Table 1– Measures of Production With Fixed
Capital

Lecture 7, Chapter 7
APL and MPL Curves
Figure 1 displays the average and marginal product
of labor from table 1 in a graph.
Holding capital constant, the marginal product of
labor eventually diminishes.
This is the Law of Diminishing Marginal Returns
As long as MPL>APL however, the average product
of labor is rising.

Lecture 7, Chapter 7
Mathematical Example of APL and MPL
Suppose, it is a production function for carpets then
find APL, MPL and TPL where K =10

Q  600 K L  K L 2 2 3 3
Steps to Solve

• Take MPL and put it equal to zero

•Find APL and then Take partial Derivative with respect to
Labor and put it equal to zero to find number of labor.
•At that point where APL = MPL , APL would be maximum.

Key: L= 40, Q = 32 Million, Which means that if the firm hires labor
beyond 40 units, it will reduce the overall production of the firm.

Lecture 7, Chapter 7
Sample Questions
Suppose the following production function is

Q K *L
Then find APL and MPL , APK and MPK

Suppose the following production function is

Q  KL  0.8 K  0.2 L 2 2

Then
• find APL and MPL if K=12,
•Find APK and MPK if L=5

Lecture 7, Chapter 7
 Laws of Returns ( Short Run Analysis of
theory of Production)
Law of Increasing Return
If each additional unit of labor with fixed capital gives
more production as compare to previous unit, it means
that production follows Law of Increasing Return
Law of Constant Return
If each additional unit of labor with fixed capital gives
same production as compare to previous unit, it means
that production follows Law of Constant Return
Law of Diminishing Return
If each additional unit of labor with fixed capital gives
less output as compare to previous unit of labor, it
means that production follows Law of Diminishing
Return

Lecture 7, Chapter 7
 Rationale
Tabular Example

(3) (3)
(1) Marginal Product Average
Units of the (2) (MP), Product
Variable Resource Total Product Change in (2)/ (AP),
(Labor) (TP) Change in (1) (2)/(1)
0 0 -
1 10
] 10 Increasing 10.00
2 25
] 15 Marginal
12.50
Returns
3 45
] 20
15.00
4 60
] 15
Diminishing 15.00
5 70
] 10 Marginal 14.00
6 75
] 5 Returns
12.50
75
] 0 Negative
10.71
7
] -5 Marginal
8.75
8 70 Returns
Lecture 7, Chapter 7
Graphical Portrayal

Total Product, TP
30
TP

20

10

0
1 2 3 4 5 6 7 8 9
Marginal Product, MP

Increasing Diminishing Negative

Marginal Marginal Marginal
20 Returns Returns Returns

10 AP

1 2 3 4 5 6 7 8 9
MP
Lecture 7, Chapter 7
 Law of Variable Stage -1
Proportion S
Stage -2 t
(Variable Labor a
and g
Fixed Capital) e
-
3

Lecture 7, Chapter 7
 Equilibrium of a firm in Theory
of Production
For Equilibrium of a firm in theory of production , two
concepts are required
ISO Quant And ISO Cost
ISO Quant
It is an aggregation of those combinations of
inputs (K,L) which are giving same level of
output . Each ISO Quant indicates that how
quantities of two inputs are may be substituted
for one an other in producing the desired level
of output.
ISO Cost
It means that combination of inputs (K,L) on
which same cost has been occurred.

Lecture 7, Chapter 7
Properties of ISO Quant
Downward Sloping
DMRTS( Diminishing Marginal Rate of Technical
Substitution
Higher is better
Never intersect each other

Lecture 7, Chapter 7
Slope of the Isoquant
The slope of the iso-quant is the additional capital K
required per unit of labor L given up that maintains
output.
We call this slope, the marginal rate of technical
substitution or MRTS.
The slope varies along the iso-quant.

Lecture 7, Chapter 7
Figure 6--Marginal Rate of Technical
Substitution Along an Isoquant

Lecture 7, Chapter 7
Marginal Rate of Technical
Substitution (MRTS)
Definition:
The MRTS is the slope of the ISO-quant or trade-off
between two inputs, holding output constant.
In terms of Figure 6,
K
(3) MRTS  ,
L

This is the units of capital required per unit of

labor sacrificed along the ISO-quant.

Lecture 7, Chapter 7
Derivation of the MRTS
Q=F(L,K) is the production function.
Since Q=Q0 along an isoquant we have Q=Q0=F(L,K).
Now differentiate Q0=F(L,K). The result is

F F
(4) Q0  0  L  K
L K

Lecture 7, Chapter 7
Derivation of the MRTS
The ratio terms in (4) are the marginal products of
each input, which hold the other input constant.
Thus,

F F
(5) MPL  , MPK 
L
Inserting (5) into (4) we reach, K

( 6) 0  MPL L  MPK K
Lecture 7, Chapter 7
Derivation of the MRTS
Solving (6) for the change in K
MPL
(7 ) K   L
MPK

MRTS is the expression on the right of (8).

K MPL
(8) MRTS   
L MPK

Lecture 7, Chapter 7
Equilibrium Condition
 Slope of ISO Quant must be equal to slope of ISO
Cost
OR
MRTS = W/R

Lecture 7, Chapter 7
Practice Questions
Suppose, the following production function then

 Find APL and MPL if K=15

Find that level of labor at which APL is maximum

 Find that level of output where MPL is equal to APL.

Q  KL  0.46 K  0.22 L 2 2

Lecture 7, Chapter 7
Practice Question
Suppose the following production function then find
the equilibrium level with the help of Lagrange
Multiplier.

Q K *L
Where Constraint function is TC= w*L+ r*K

Lecture 7, Chapter 7