Presentation On Production Function and Cost Analysis

PRODUCTION FUNCTION
AND COST ANALYSIS

GROUP MEMBERS:
Asad Ullah
Aleem Inam
Fasih Abbas
Muhammad Sheraz
Umar Farooq
THE PRODUCTION FUNCTION
WHAT IS PRODUCTION?
• Production is a process of combining various material

inputs and immaterial inputs (plans, know-how) in order
to make something for consumption (output).
• Any activity that creates value.

FACTORS OF PRODUCTION
PRODUCTION FUNCTION
• Production Function- measures the relationship between

Qty of inputs and Qty of output
Inputs:
• Labor
• Capital (human & physical) Production Total
• Natural Resources Function Product (TP)
(output)
• Entrepreneurial Talent
PRODUCTION FUNCTION
It can be written as:

Q=F(L,K,M)
Where, Q stands for quantity of output
L stands for Labor
K stands for Capital
M stands for Material
FIXED OR VARIABLE
a) Fixed inputs are those that can’t easily be increased

or decreased in a short period of time.
b) Variable inputs are those that can easily be
increased or decreased in a short period of time.
TYPES OF PRODUCTION FUNCTIONS
A. Short-run Production-functions or the Law of Variable Proportions
B. Long-run production function or Returns to Scale

SHORT-RUN PRODUCTION-FUNCTIONS OR THE
LAW OF VARIABLE PROPORTIONS
• The law of variable proportion states that as more and more variable function
are combined with fixed factor, “Marginal product of variable factor may
initially rise but eventually situation must come, where the marginal product
of variable factor decline it may become zero or negative.
For Example: FF VF TP MP
1 0 0 -
1 1 6 6
1 2 20 14
1 3 48 28
1 4 72 24
1 5 80 8
1 6 84 4
1 7 84 0
1 8 80 -4
IN THE SHORT RUN THERE ARE THREE MAIN
CONCEPTS OF PRODUCTION
a) Total Product
b) Average Product
c) Marginal Product
TOTAL PRODUCT
• Total product of a factor is the amount of total output

produced by a given amount of the factors, other factors
held constant.
TP=AP*L
Where AP= Average Productivity of a factor
L= Labor
AVERAGE PRODUCT
• Average product of a factor is the total output per unit of

the factor employed
AP= TP/Q
Where TP= Total Product
Q= No of variable factor (No. of labour)
MARGINAL PRODUCT
• Marginal product of a factor is the addition to the total

production by employment of an extra unit of a factor.
MP= Change in quantity

Change in factor
Where Q= Change in total product
L= Change in quantity of factor input
RELATION BETWEEN TP & MP &
RELATIONSHIP BETWEEN MP & AP
FF VF TP MP AP
1 0 0 - -
1 1 6 6 6
1 2 20 14 10
1 3 48 28 16
1 4 72 24 18
1 5 80 8 16
1 6 84 4 14
1 7 84 0 12
1 8 80 -4 10
CAUSES OF INCREASING/DECREASING
RETURN TO A FACTOR
Causes of increasing return to a factor

• Full utilization of fixed factor
• Division of labor and increase in efficiency
• Better co-ordination between the factor
Causes of decreasing return to a factor
• Less utilization of the factor
• Imperfect co-ordination between the factors
ASSUMPTION FOR LAW OF PROPORTION
• Ratio can be changed

• Variable factor are homogeneous
• Technology does not change
LONG-RUN PRODUCTION FUNCTION OR RETURNS
TO SCALE
• In long-run all factors of input can be varied. It means, that in the long-run
we can expand or reduce the scale of production as well. The way in which
the output varies with the changes in the scale of production is discussed in
the long-run production function. The law which states this relationship is
also called as return to scale.
IN THE LONG RUN THERE ARE TWO RELATIVE
CONCEPTS OF PRODUCTION
A. Iso-quant curve
B. Iso-cost line
ISO-QUANT/PRODUCT
• An isoquant may be defined as a curve showing all the
various combinations of two factors that can produce a
given level of output.
• The isoquant shows the whole range of alternative ways
of producing the same level of output.
ISO-COST
• An ISO-Cost line is also called as price line or factor cost

line.
• It shows all the possible combinations of labor and
capital that are available for a given total cost to the
producer.
PRODUCTION POSSIBILITY FRONTIER
• The collection of all the possible combinations of goods

and services that can be produced from a given amount
of resources and given technology is called the
Production Possibility Frontier.
• Example: An economy which can produce butter or gun
by using its resources. The given table shows the
combination or producing butter or gun.
PRODUCTION POSSIBILITY CURVE
COST ANALYSIS
INTRODUCTION OF COST
• Economic costs includes the payments such as rent,

wages, interest and profit, which are paid to factors of
production – i.e. land, labor, capital, entrepreneurship for
their services.
OPPORTUNITY COST
• Factors of production or resources, in an economy are limited and have

alternative uses. The cost of sacrifice or foregone for the next best use of
resources is known as opportunity cost.
Sunk Cost
• A cost that already has been incurred and thus cannot
be recovered.
COST FUNCTIONS
• Short Run Cost Function

• Long Run Cost Function
SHORT-RUN COST FUNCTION
• In short-run, some of the firm’s input are fixed and some
are variable, and this leads to fixed and variable costs.
• Fixed Cost
• Variable Cost
• Total Cost
• Average Fixed Cost
• Average Variable Cost
• Average Total Cost
• Marginal Cost
SHORT-RUN COSTS FUNCTION
• Fixed Cost
Fixed costs are those costs which do not change with
the change in level of output.
• Variable Cost
Variable costs are those costs which change with the
change in level of output when output is zero, the variable
cost also zero. It will increase with the increase in level of
output. E.g electricity charges
• Total Cost
Total cost is the cost of all the productive resources
used by the firm.
TC=TFC+TVC
• Average Fixed Cost
It can be calculated by dividing total fixed cost with
the level of output. As the level of output increases, the
average fixed cost decreases.
AFC=TFC/Q
• Average Variable Cost
It is the per unit cost of the variable factors of
production. It can be calculated dividing total variable
cost by output.
AVC=TVC/Q
• Average Total Cost
Average cost is the total cost per unit. It can be
found out as follows
ATC=TCP/Q
• Marginal Cost
Marginal cost is an addition made to total cost by the
production of one more unit of output.
MC= TC/ Q
CALCULATION TABLE
SHORT-RUN CURVES
LONG-RUN COST CURVES
• In long-run all the factors of production are changeable.

In long-run a firm can increase its capacity, equipment,
machinery, land, employee, etc. in order to increase the
output.
• Long-run total cost is the minimum total costs of

producing various levels of output when the firm can
build any desired scale of plant.
LTC=f(Q)
• Long-Run Average Cost is the minimum per unit cost of
producing any level of output when the firm can build
any desire scale of plant.
LAC=LTC/Q
• Long-Run Marginal Cost is the change in long-run total
costs per unit change in output.
LMC= LTC/ Q

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PRODUCTION FUNCTION

AND COST ANALYSIS

• Production is a process of combining various material

• Any activity that creates value.

• Production Function- measures the relationship between

It can be written as:

a) Fixed inputs are those that can’t easily be increased

A. Short-run Production-functions or the Law of Variable Proportions

B. Long-run production function or Returns to Scale

• Total product of a factor is the amount of total output

• Average product of a factor is the total output per unit of

• Marginal product of a factor is the addition to the total

MP= Change in quantity

Causes of increasing return to a factor

• Ratio can be changed

• An ISO-Cost line is also called as price line or factor cost

• The collection of all the possible combinations of goods

• Economic costs includes the payments such as rent,

• Factors of production or resources, in an economy are limited and have

• Short Run Cost Function

• In long-run all the factors of production are changeable.

• Long-run total cost is the minimum total costs of

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