Market structures

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PRODUCTION Production is simply the conversion of inputs into outputs . It is an economic process that uses resources to create a commodity that is suitable for exchange . This can include manufacturing, storing, shipping, and packaging. In production process, a firm combines various inputs in different quantities and proportions to produce different levels of outputs. Some economists define production broadly as all economic activity other than consumption. They see every commercial activity other than the final purchase as some form of production. Production is a process, and as such it occurs through time and space. Because it is a flow concept, production is measured as a “rate of output per period of time”. A production process can be defined as any activity that increases the similarity between the these goods available to the market pattern of demand for goods, and the quantity, form, and distribution of place.

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Aspects There are three aspects to production processes: the quantity of the commodity produced, the form of the good created, the temporal and spatial distribution of the commodity produced

Factors of production :

Factors of production In economics , factors of production are resources used in the production of goods and services, including land , labor , and capital . The inputs or resources used in the production process are called factors by economists. The myriad of possible inputs are usually grouped into four or five categories. Raw materials Labour services Capital goods Land Enterpreneur

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In the “long run” all of these factors of production can be adjusted by management. The “short run” however, is defined as a period in which at least one of the factors of production is fixed. A fixed factor of production is one whose quantity cannot readily be changed. Examples include major pieces of equipment, suitable factory space, and key managerial personnel. A variable factor of production is one whose usage rate can be changed easily. Examples include electrical power consumption, transportation services, and most raw material inputs. In the short run, a firm’s “scale of operations” determines the maximum number of outputs that can be produced. In the long run, there are no scale limitations.

Production Function :

Production Function Managers must decide not only what to produce for the market, but also how to produce it in the most efficient or least cost manner. Economics offers widely accepted tools for judging whether the production choices are least cost. A production function relates the most that can be produced from a given set of inputs. Production functions allow measures of the marginal product of each input.


Definition A Production Function is the maximum quantity from any amounts of inputs. A production function describes a mapping from quantities of inputs to quantities of an output as generated by a production process. It is the name given to the relationship between rates of input productive services and the rate of output of product. It is the economist summary of technical knowledge. A production function refers to the functional relationship, under the given technology, between physical rates of input and output of a firm, per unit of time.

Algebraic Statement of Production Function:

Algebraic Statement of Production Function Q=f( a,b,c,d ,….n, T) where Q=physical quantity of OP (commodity produced)/unit of time. F=functional relationship A,b,c,d,n -quantities of various inputs (productive factors) per employed time period. T-prevailing state of technology which is constant. A simple Production Function assuming two factor model would be Qx =f(K, L) where Qx -rate of OP of commodity X per unit of time. K=units of capital used per unit of time L= labour units employed per unit of time

A Hypothetical Production Function:

A Hypothetical Production Function Units of Labour (L) Out put Quantity (Q) 6 46 61 80 88 95 85 5 50 65 85 95 100 90 4 45 60 80 90 96 85 3 35 50 70 80 85 75 2 15 30 50 60 65 55 1 5 20 40 50 55 45 1 2 3 4 5 6 Units of Capital (K)

Attributes of PF:

Attributes of PF Flow concept- Flow of inputs and the resulting flows of OP of a commodity during a period of time. Physical concept : Expressed in physical terms not in monetary units State of Technology : The sum total of knowledge of the means and methods of producing goods and services. Includes methods of organization and techniques of production. Inputs Inputs ( a,b,c,d ,………..n) are complementary in nature as their combined productive services are transformed into production of a specific commodity. Some inputs are substitutes to one another Ex: if a and b are substitutable factors, a may be increased instead of b.A is fixed while be is variable at a time. In reality factors like L and K are not perfectly substitutable, but there may be sufficiently high degree of substitutability Some inputs may be specific. Factor’s Combination for the Maximum OP SR and LR Production Function : SRPF pertains to a given scale of production. LRPF pertains to the changing scale of production.

Time Element and Production Functions:

Time Element and Production Functions The Short Run PF The Long Run Pf

The Short Run Production Function:

The Short Run Production Function Fixed Factors: Plant, Machinery and equipment. Also land, manager or administrative staff. Variable Factors: OP Varies only by varying the variable factors combined within the given set of fixed factor inputs. Q=f(a/b0,c0,…….n0, T) Stoke (/)divides between variable and fixed components. Subscript 0 at the top is used denote fixed factors a is the variable factor b,c are quantities of fixed factors T-technology is constant.

The Short Run Production Function:

Two Kinds of SR Production Function : Quantities of all inputs both fixed and variable will be kept constant and only one variable input will be varied Ex: Law of variable Proportions Quantities of all factor inputs are kept constant and only two variable inputs are varied. Ex: Iso-Quants and Iso -Cost Curves The Short Run Production Function

The Long Run PF:

The Long Run PF Operates with changing scale of OP, Size. Q=f(a,b,c,….n, T) All factors are variable except T which is held constant for analytical convenience. If old production function is disturbed and new one takes its place, it may be in the following manner- The quantity of inputs may be reduced while the quantity of output may remain same. The quantity of output may increase while the quantity of inputs may remain same. The quantity of output may increase and quantity of inputs may decrease.

Types of Production Functions:

Types of Production Functions Cobb Douglas Production Function Constant Elasticity Substitution (CES) PF Variable Elasticity of Substitution PF Leontief-Type PF Linear-Type PF Of all these types Cobb Douglas Production Function and Constant Elasticity Substitution (CES) PF are widely used.

Cobb-Douglas Production Function :

Cobb-Douglas Production Function In economics, the Cobb-Douglas functional form of production functions is widely used to represent the relationship of an output to inputs. It was proposed by Knut Wicksell (1851-1926), and tested against statistical evidence by Paul Douglas and Charles Cobb in 1928. CW Cobb and PH Douglas made a statistical enquiry into some manufacturing industries in America and other countries to trace the empirical relations between changes in physical inputs and the resulting OP. For production, the function is Q = A • L  • K  is a Cobb-Douglas Production Function where: Y = output L = labor input K = capital input A , α and β are constants determined by technology.

Properties of Cobb-Douglas Production Function:

Properties of Cobb-Douglas Production Function 1. Both L and K should be positive for W to exist. If either of these are zero Q will be zero. Q = A • • L  K  is a Cobb-Douglas Production Function 2. If α + β = 1, the production function has constant returns to scale. That is, if L and K are each increased by 20%, Y increases by 20%. If α + β < 1, returns to scale are decreasing, and if α + β > 1 returns to scale are increasing

Properties of Cobb-Douglas Production Function:

Properties of Cobb-Douglas Production Function 3. Another important feature of the function is that its parameters represent factor shares in OP. Assuming perfect competition, α and β can be shown to be labour and capital's share of output. Ex: α = Wage Share/ Total Income and β = Rental Share / Total Income 4. We can also find the short run relationship of inputs and output (ex: Marginal Product of Labour and Marginal Product of Capital ) with the help of this function. For 2 input case MPL =  (Q/L)and MPK =  (Q/K) Cobb and Douglas, were influenced by statistical evidence that appeared to show that labour and capital shares of total output were constant over time in developed countries. There is now doubt over whether constancy over time exists.

CES Production Function:

CES Production Function CBPF Elasticity if substitution is equal to unity but in CES the elasticity of substitution is constant and not necessarily equal to unity. Widely used apart from the CBPF. Expressed as Q = A[ α K – β + (1 - α ) L – β ] –1/ β Q= A[ α L – β + (1 - α ) K – β ] –1/ β Homogenous of degree 1. A > 0 , 0< α < 1 β > -1 L= Labour, K= Capital, A, α, β = 3 parameters. CES is proved by increasing Capital and Labour by a constant factor and finding final outcome.

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The exponents α and β are output elasticities with respect to labor and capital, respectively. Output elasticity measures the responsiveness of output to a change in levels of either labor or capital used in production, ceteris paribus . For example if α = .015, a 1% increase in labor would lead to approximately a 1.5% increase in output. Coefficients are elasticities  is the capital elasticity of output, often about .67  is the labor elasticity of output, often about .33 which are E K and E L Most firms have some slight increasing returns to scale

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Advantages: More general form of PF. Used to analyze al the types of returns to scale. Removes many problems involved in CBPF. Limitations : General form does not stand empirical test. Difficult to fit this function to empirical data. Difficult to generate this function to n- number of factors. Parameter β combines the effects of 2 factors L and K. When technology changes, given the scale of production, homogeneity parameter β may be effected by both the inputs. Doesn’t provide a measure to separate the effects on the productivity of inputs.

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