What is Production?

In economics, Production is a process of transforming tangible and intangible inputs into

goods or services.
Raw materials, land, labour and capital are the tangible inputs, whereas ideas, information
and knowledge are the intangible inputs. These inputs are also known as factors of
production.

Business firms are important components (units) of the economic system. They are artificial
entities created by individuals for the purpose of organising and facilitating production. The
essential characteristics of the business firm is that it purchases factors of production such as
land, labour, capital, intermediate goods, and raw material from households and other
business firms and transforms those resources into different goods or services which it sells to
its customers, other business firms and various units of the government as also to foreign
countries.

Definition of Production:
“Production is the organised activity of transforming resources into finished products in the
form of goods and services; the objective of production is to satisfy the demand for such
transformed resources”.

Three Types of Production:

For general purposes, it is necessary to classify production into three main groups:
1. Primary Production:
Primary production is carried out by ‘extractive’ industries like agriculture, forestry, fishing,
mining and oil extraction. These industries are engaged in such activities as extracting the
gifts of Nature from the earth’s surface, from beneath the earth’s surface and from the oceans.

2. Secondary Production:
This includes production in manufacturing industry, viz., turning out semi-finished and
finished goods from raw materials and intermediate goods— conversion of flour into bread or
iron ore into finished steel. They are generally described as manufacturing and construction
industries, such as the manufacture of cars, furnishing, clothing and chemicals, as also
engineering and building.

3. Tertiary Production:
Industries in the tertiary sector produce all those services which enable the finished goods to
be put in the hands of consumers. In fact, these services are supplied to the firms in all types
of industry and directly to consumers. Examples cover distributive traders, banking,
insurance, transport and communications. Government services, such as law, administration,
education, health and defence, are also included.
Concepts of Production

In the production process, the output or product may be described in three (3) ways in
economics: Total Product (TP), Average Product (AP), and Marginal Product (MP).

1) Total Product (TP):

Total Product is the maximum output that a firm can produce over a given period of time
when it employs a given set of inputs.

2) Average Product:

Average Product is the output per unit of the variable factor employed. In other words, it is
the productivity of the variable factor. It is measured by dividing Total Product (TP) by the
amount of variable factor employed i.e.

AP=TP/Variable factor employed

Average Product is measured in respect of a variable factor. For instance, where the variable
factor is labour (L), then, it is the Average Product of Labour (APL) or the productivity of
labour that we can measure as:

APL=TP/L
From this, it can be gotten that TPL=APL×L

3) Marginal Product (MP):

Marginal Product is the change in the Total Product resulting from the use of one more (or
less) unit of a variable factor. It may also be explained as the rate of change in Total Product
with respect to a variable factor i.e.

MP=ΔTP/ΔVariable Factor
Where Δ = Change.

For example, the Marginal Product of Labour (MPL) is measured as:

MPL=ΔTP/ΔL

Factors of Production
Anything that helps in production is the factor of production. These are the various factors by
mean any resource is transformed into a more useful commodity or service.

They are the inputs for the process of production. They are the starting point of the production
process. Factors of production are the parameters which affect the output of production.

Types of Factors of Production

Factors of production have been categorized into four types.

Land

It refers to all natural resources. All natural resources either on the surface of the earth or below
the surface of the earth or above the surface of the earth is Land.

One uses the land to produces goods. It is the primary and natural factor of production. All gifts
of nature such as rivers, oceans, land, climate, mountains, mines, forests etc. are land.

The payment for land is rent.

Characteristics of Land as a Factor of Production

 The land is a free gift of nature.

  The land has no cost of production.

 It is immobile.

 The land is fixed and limited in supply.

Labour

All human effort that assists in production is labour. This effort can be mental or physical. It is a
human factor of production. It is the worker who applies their efforts, abilities, and skills to
produce.

The payment for labour is the wage.

Characteristic

 It is a human factor.

 One cannot store labour.

 No two types of labour are the same.

Capital

Capital refers to all man-made resources used in the production process. It is a produced factor
of production. It includes factories, machinery, tools, equipment, raw materials, wealth etc.

The payment for capital is interest.

Characteristics

 Capital is a manmade factor of production.

 It is mobile.

 It is a passive factor of production.

Entrepreneur

An entrepreneur is a person who brings other factors of production in one place. He uses them
for the production process. He is the person who decides

 What to produce

 Where to produce

 How to produce
A person who takes these decisions along with the associated risk is an entrepreneur.
The payment for land is profit.

Characteristics

 He has imagination.

 He has great administrative power.

 An entrepreneur must be a man of action.

 An entrepreneur must have the ability to organize.

 He should be a knowledgeable person.

 He must have a professional approach.

Production Function:
Production is the result of co-operation of four factors of production viz., land, labour, capital
and organization. This is evident from the fact that no single commodity can be produced
without the help of any one of these four factors of production.
Defined production function as
“the relation between a firm’s physical production (output) and the material factors of
production (inputs).”
In this way, production function reflects how much output we can expect if we have so much
of labour and so much of capital as well as of labour etc. In other words, we can say that
production function is an indicator of the physical relationship between the inputs and output
of a firm.

Mathematically, such a basic relationship between inputs and outputs may be expressed as:

Q = f( L, C, N )

Where Q = Quantity of output

L = Labour

C = Capital

N = Land.

Production is the result of combined efforts of the factors of production. These factors may be
fixed or variable. A fixed factor is one, whose quantity cannot readily be changed in response
to desired changes in output or market conditions.
Its quantity remains the same, whether the level of output is more or less or zero. Buildings,
land, machinery, plants and top management are some common examples of fixed factors. A
variable factor, on the other hand, is one whose quantity may be changed in response to a
change in output. Raw materials, ordinary labour, power, fuel, etc. are examples of variable
factors. Such factors are required more, when output is more; less, when output is less and
zero, when output is nil. For the sake of analytical simplicity, semi-variable factors are not
considered here.

Law of Variable Proportion

Law of Variable Proportion:

Law of Variable Proportion is regarded as an important theory in Economics. It is referred to

as the law which states that when the quantity of one factor of production is increased, while
keeping all other factors constant, it will result in the decline of the marginal product of that
factor.
Law of variable proportion is also known as the Law of Proportionality. When the variable
factor becomes more, it can lead to negative value of the marginal product.
The law of variable proportion can be understood in the following way.
When variable factor is increased while keeping all other factors constant, the total product
will increase initially at an increasing rate, next it will be increasing at a diminishing rate and
eventually there will be decline in the rate of production.

Assumptions:
Law of variable proportions is based on following assumptions:
(i) Constant Technology:
The state of technology is assumed to be given and constant. If there is an improvement in
technology the production function will move upward.

(ii) Factor Proportions are Variable:

The law assumes that factor proportions are variable. If factors of production are to be
combined in a fixed proportion, the law has no validity.

(iii) Homogeneous Factor Units:

The units of variable factor are homogeneous. Each unit is identical in quality and amount
with every other unit.

(iv) Short-Run:
The law operates in the short-run when it is not possible to vary all factor inputs.

By keeping land as a fixed factor, the production of variable factor i.e., labour can be
shown with the help of the following table:
rom the table 1 it is clear that there are three stages of the law of variable proportion. In the
first stage average production increases as there are more and more doses of labour and
capital employed with fixed factors (land). We see that total product, average product, and
marginal product increases but average product and marginal product increases up to 40
units. Later on, both start decreasing because proportion of workers to land was sufficient and
land is not properly used. This is the end of the first stage.

The second stage starts from where the first stage ends or where AP=MP. In this stage,
average product and marginal product start falling. We should note that marginal product
falls at a faster rate than the average product. Here, total product increases at a diminishing
rate. It is also maximum at 70 units of labour where marginal product becomes zero while
average product is never zero or negative.

The third stage begins where second stage ends. This starts from 8th unit. Here, marginal
product is negative and total product falls but average product is still positive. At this stage,
any additional dose leads to positive nuisance because additional dose leads to negative
marginal product.

Stages of Law of Variable Proportion

The Law of Variable proportions has three stages, which are discussed below.

1. First Stage or Stage of Increasing returns: In this stage, the total product increases at
an increasing rate. This happens because the efficiency of the fixed factors increases
with addition of variable inputs to the product.
2. Second Stage or Stage of Diminishing Returns: In this stage, the total product
increases at a diminishing rate until it reaches the maximum point. The marginal and
average product are positive but diminishing gradually.
 3. Third Stage or Stage of Negative Returns: In this stage, the total product declines and
the marginal product becomes negative.

Graphic Presentation:
In fig. 1, on OX axis, we have measured number of labourers while quantity of product is
shown on OY axis. TP is total product curve. Up to point ‘E’, total product is increasing at
increasing rate. Between points E and G it is increasing at the decreasing rate. Here marginal
product has started falling. At point ‘G’ i.e., when 7 units of labourers are employed, total
product is maximum while, marginal product is zero. Thereafter, it begins to diminish
corresponding to negative marginal product. In the lower part of the figure MP is marginal
product curve.

Up to point ‘H’ marginal product increases. At point ‘H’, i.e., when 3 units of labourers are
employed, it is maximum. After that, marginal product begins to decrease. Before point ‘I’
marginal product becomes zero at point C and it turns negative. AP curve represents average
product. Before point ‘I’, average product is less than marginal product. At point ‘I’ average
product is maximum. Up to point T, average product increases but after that it starts to
diminish.