2.

PRODUCTION FUNCTIONS

1
Important concepts
• What is a production function?
– It represents a technical relationship between
inputs (resources or factors of production) and
output

– For a particular technology, a production

function describes how inputs are transformed
into outputs

2
Example:

• The rate at which fertilizer that is applied

into the soil combines with moisture and
sunlight and gets transformed into maize or
beans

3
Production function …
• May be represented in mathematical, graphic or
tabular forms

• Symbolically the production function may be

written as:
Y = f (X) (2.1)
Where; Y = output (dependent variable)
X = input for X  0 (independent
variable or variable input)
4
• In the case of more than one
independent variable input the
production function may be written
as:
Y = f (X1, X2, X3,…………, Xn) (2.2)

• The exact functional form of the

production function depends on the
technology
5
• Equation 2.3 gives a specific
example of a production
function with one variable
input:

6
• In a production function, each
value of Y is assigned to at
least one value of X
– Two or more values of X can relate to the
same value of Y, but the converse is not true
– No value of X can relate to two different
values of Y
– This is a cardinal rule of mathematical
functions
7
Production function may be
determined …
• Through experiments as in the case of
fertiliser rates

• By studying farm records involving a

homogenous group of farmers

• By using a combination of experiments and

available farm record
8
Table 2.1: A hypothetical example of the
production function in tabular form
Quantity of Nitrogen (Kg/ha) Yield of Maize (Kg/ha)
0 6,276
45 9,415
90 13,181
135 14,436
180 15,441
225 16,068
265 15,566
9
Figure 2.1: Graphical representation of
production function
Y
D
112

C TPP

60
B

X
0 1 2 3 4 5 6 7 8 9 10
10
Fixed Vs Variable Inputs
&
The Length of Run

11
• When we represent the production
function in terms of inputs and output:

Y = f (X) (2.4)

– The model is actually oversimplified

because it is assumed that all the
other inputs that go into the
production process are held constant
except for the variable input of
interest during this analysis
12
• For example: in the case of variations
in the quantity of nitrogen, we assume
that other inputs such as land, labour,
pesticides, moisture are held constant
as the amount of fertiliser is varied

13
• This should symbolically be represented
as:
Y = f (X1, X2, X3, X4, ………….Xn ) (2.5)

• In equation (2.5), X1 is the variable input

• While X2, X3, …………. Xn are fixed inputs

- meaning that they are held constant as X1
is varied (all other things being equal or
ceteris paribus)
14
Fixed Vs Variable Inputs …
i. A variable input - is an input
that the farm manager can
control or for which s/he can
alter the level of use

– This implies that the farmer has

sufficient time to adjust the amount
of the input used
15
ii. A fixed input - is usually defined as
an input, which for some reason the
farmer cannot change during the
production period

– The set of fixed inputs is also referred to

as the plant

16
• Example: Once the
production season has just
started, the amount of land
available to the farmer can be
considered as being fixed

17
• The farm manager may be facing
fixed inputs due to:
1) Time
2) Economic prudence - such as in a situation
where increasing or decreasing the input would
reduce profits (e.g. the amount of yeast in
bread making)
3) A personal decision - such as in a situation
when the farmer is doing an experiment to
determine the milk production response when
the ration is changed
18
The Length of Run …
• Given enough time however, the
amount of all inputs can be changed
• Thus economists define production
situations as they relate to inputs in
three phases:
– The very short run phase
– The short or intermediate run phase
– The long run phase
19
1) The very short run - this is a length of
time too short for the firm manager to
change any of the inputs. Thus in the
very short run all inputs are fixed

• An example is a production season once it

commences
– The farmer will have assembled all the inputs
and most of them cannot be returned to the
stores
– As such they may be considered as being fixed

20
2) The short run or intermediate run - a
time period of such length that at least
one of the inputs is variable

21
3)The long run - a time period
of such length that all inputs
can be varied
• Example: before plans are put
into effect, all inputs are variable

22
• However, these periods are rather
arbitrary defined to simplify
economic analysis
– In practice, farmers are always faced with
some fixed input as the production season
proceeds
– They are essentially moving from one short
run to another

23
Important Assumptions
Underlying

Production Functions

24
1) Perfect certainty
• When production functions are given,
representing the technical relationship
between inputs and outputs, it is
assumed that the technology is perfect
and farm managers make their
production plans under conditions of
certainty
25
• But in reality, there is a lot of risks
and uncertainties with regard to the
efficiency of the production process as
well as prices
Agricultural production involves a lot of
inputs that cannot be controlled
The weather
Government policies
Events in other countries, etc.
26
• As such, last year’s production is
only a guide to this year’s
production decisions

The assumption of perfect

certainty is made to simplify the
real world so as to facilitate
analysis
27
Example: Uncertainty related to
weather variations
Yield Good rainfall

Uncertainty
Too much rain

Dry year

Fertilizer
Figure 2.3 Uncertainty due to Weather Variations
28
2) Level of technology
• It is assumed that farmers use the
most efficient technology
available to them
That is, the process that gives the
most output for the given level of
inputs

29
That is …
If farmers don’t use the most
efficient technology available -
possibly because they are not aware
of it or they cannot afford it
Example: farmers continue to use the hand
hoe because they cannot afford or they do
not have access to more efficient tools of
primary and secondary tillage
30
3) Length of time
• It is assumed that the farmer manager is
operating in one of the time periods in
relation to inputs used as discussed
earlier:
The very short run (when all inputs are fixed)
The short run (when at least one input is
variable)
The long run (when all inputs are variable)
31
2.2 Factor Product Relations

32
Classical production function
• Is used to display all the characteristics
necessary for the purpose
– i.e. describing production relationships in agriculture

• Example of the classical production functions:

Y = 3X + 2X2 – 0.1X3 (2.6)

33
Important concepts

1) Total Physical Product (TPP)

= The total output (Y )

Note: the variable input is

denoted as X
34
TPP …
Output
per
Month D
112

C TPP

60
B

0 1 2 3 4 5 6 7 8 9 10 Labor per Month

35
2) Average Physical Product (APP)
• The ratio of output to variable input
• Is obtained by dividing the TPP (Y ) by the
variable input (X ):
APP = Y / X (2.7)

36
APP …
• Measures the average rate at which
inputs are transformed into output
• Measures the efficiency of
production
• Measures the efficiency of using
variable costs
37
• The shape of APP curve depends on
the shape of production function

• Geometrically the APP is defined as

the slope of a ray from the origin
that intersects or is tangent to the
TPP

38
 Plotting the APP Curve

B APP = Y*/X*
= Slope of the line from
the origin to the point
on the TPP curve
A At X**, APP is at a maximum,
as line OB is just tangent
Y*
to the TPP curve
0 X
X*
X**

39
• From the production function
presented in equation (2.6)

Y = 3X + 2X2 – 0.1X3

APP = 3 + 2X – 0.1X2 (2.8)

40
• Note that for the production
function given above, the APP is
not defined when X = 0

–Even though the algebraic function

(2.8) implies that APP = 3 at this
point, rather, 3 represents the limit
of the APP as X approaches 0

41
3) Marginal Physical Product (MPP)
• Is defined as the change in output resulting
from a unit incremental change in variable
input
• The shape of the MPP curve depends on the
shape of the production function
• Geometrically, the MPP represents the slope
of the production function

42
Two ways to compute
MPP:
1) Average MPP: is computed using
tabular data of a production function

43
2)Exact MPP: is computed when a
continuous differentiable
production function is defined

• It is the 1st derivative of the TPP

obtained using differential calculus

44
45
• Average MPP between two points on
a production function is an
approximation of the exact MPP of
points that lie between the two points

• Thus there will always be a

difference between the exact and
average MPP computed for a given
point using tabular data and calculus

46
For a classical production function
• When MPP is increasing, TPP is increasing
at an increasing rate

• When MPP is decreasing but positive, TPP

is increasing at a decreasing rate

• When MPP is zero, TPP attains a maximum

• When MPP is negative, TPP is decreasing

47
A classical production function

Point of inflection

48
 Relationship Between APP and MPP

Qt of
Output APP is at a maximum at
MPP input level where APP = MPP
E
APP*

APP

Qt of
0 Input
X*
Observations:
Left of E: MPP > APP & APP is increasing
Right of E: MPP < APP & APP is decreasing
E: MPP = APP & APP is at its maximum 49
 2.3 The Law
of
Diminishing Returns
50
LDR
• Was developed by early
economists to describe the
relationship between output
and a variable input when
other inputs are held constant

51
It states that:
If increasing amounts of input are
added to a production process while
all other inputs are held constant,
the amount of output added per
additional unit of variable input will
eventually decrease

52
 LDR …
Units of Output

196
184
TPP
161
DQ from hiring fourth worker
130
DQ from hiring third worker
90

DQ from hiring second worker

30
DQ from hiring first worker

1 2 3 4 5 6 Number of Workers

Increasing diminishing
marginal marginal returns
returns 53
The LDR…has invariably
also been stated as follows:
As units of a variable input are
added to one or more fixed
inputs, after some point, each
incremental unit of variable
input produces less and less
additional output
54
• The LDR refers to the rate
of change in the slope of the
production function
• It is also referred to as the
law of diminishing marginal
returns (LDMR)

55
LDR compared to LDMR
The LDR says nothing
about increasing returns,
even though some portions
of some production functions
may have increasing
returns
56
The LDR …
• Implies that there is a right amount
of variable inputs to be used in
combination with fixed inputs
The farm manager should not use
neither too much nor too little

57
Note that …
• The classical production
function presented earlier,
initially exhibits increasing
marginal returns followed
by diminishing marginal
returns
58
• But: for other types of
production functions marginal
returns could be decreasing
right from the first unit of
variable input applied to the
production process

59
Assumptions
of the LDR

60
1)The law assumes that the
technology is constant
That is, the method of
production remains the same
as changes are made to the
amount of variable input
61
The Effect of Technological Improvement
Output
per Labor productivity
time C can increase if there
period are improvements in
technology, even though
100 any given production
B TPP3 process exhibits
diminishing returns to
labor.

A
50 TPP2

TPP1

Labor per
time period
0 1 2 3 4 5 6 7 8 9 10
62
2) The LDR applies to changing
proportion between variable
inputs and one set of fixed inputs
 The law does not apply when all
inputs are changed simultaneously

63
• The LDR is sometimes referred to as
the law of variable proportions
– Or law of decreasing productivity

• Some people apply the LDR to

both APP and TPP
But this is not commonly done

64
2.4 Three Stages of
Production

65
The classical
production
function can be
divided into three
stages/regions
based on the
efficiency of
resource
utilization
66
Stage I: MPP > APP
APP is ↑

67
Stage I: MPP > APP
APP is ↑

It means that …
• The efficiency at
which variable
inputs are
transformed into
output, as
measured by the
APP is increasing
throughout stage I

68
Stage II: MPP < APP
MPP > 0
 Stage II starts at input use
where APP is at a maximum
 Stage II ends at input where
MPP = 0 (or TPP is at a
maximum)

69
Stage III: MPP < 0

Occurs when
excessive variable
inputs are
combined with fixed
inputs

That is why
TPP begins to
decrease

70
The efficiency of using
variable input as
measured by APP

71
• When APP
attains a
maximum at the
beginning of
stage II -
variable inputs
are used most
efficiently
72
Efficiency of using
fixed inputs

73
74
• Since the TPP attains
a maximum at the
beginning of stage
III, at this point the
ratio of output to
fixed inputs should
be the highest
• Thus...representing
the most efficient use
of fixed inputs
75
 Economic
Interpretation of the
3 Stages of Production

76
• Although the prices of inputs and
outputs must be known in-order to
determine the most profitable level of
production, some general
recommendations can be made based
on the technical relationship between
inputs and output as represented by
the production function ...

77
1) If the product is of any value at
all (i.e. it must be produced),
then variable inputs should be
used at least up to the beginning
of stage II
 Up to the point where the efficiency of
using variable inputs is highest
• This is the point where the APP attains a
maximum
78
2) Even if inputs are free,
variable inputs should not be
applied in stage III
 Because additional variable
inputs would result in a
decrease of the TPP

79
3) The boundaries of stage II
represent the limits of economic
relevance
 The optimal level of variable inputs to be
used or the level that yields the highest
level of profit occurs somewhere in stage
II

 The exact amount of input can only be

determined once input and output prices
are known
80
 Boundaries of Stage II: Limits of economic relevance
Using the amount of input in Stage I and
Q of Stage III of production is irrational from
Output the producer’s perspective. Why?

MPP

APP

Q of
Input
0
Stage I Stage II Stage III

81
 Q of
Output
Why not in this stage?

MPP

APP
Stage III

Q of
0 Input
Stage I Stage II

Average productivity is increasing as more

inputs are being used so why stop if the
average return is greater than cost? 82
 The Producer’s Economic Question
Q of
Output

MPP

APP
Stage III

Q of
0 Input
Stage I Stage II

The producer’s economic question:

What level of input amount contained in
Stage II should I use to maximize profits? 83
84
• At the boundary of stage I and II
the APP attains a maximum, which
means the slope of the APP at this
point is equal to zero

• The value of X at this point can be

determined by equating the 1st
derivative of the APP to zero and
subsequently solving for X
85
86
• The slope of the TPP = 0 when TPP is
at its maximum
Which means that the MPP = 0 at this
point
• This marks the boundary between stage
II and III
• The value of X at this point can be
determined by equating the MPP to 0
and solving for X

87
88
2.5: The elasticity of
production (p)

89
• Is defined as a measure of the
responsiveness of output to
changes in inputs
= the % change in output given a
unit % change input

• Like all other types of elasticity, p is

unitless

90
91
Types of elasticity of
production

92
• Average elasticity of production:
if the production function is
defined in tabular form or only
two co-ordinates of a production
function are defined
• Exact elasticity of production: if
a continuous differentiable
production function is defined
93
 Elasticity of product
substitution & the point
of diminishing returns

94
 At what point does the point of
diminishing returns set in?
• The determination of the point of
diminishing returns can be
ambiguous, because:
– MPP begins to diminish at the point of
inflection
– APP begins to diminish at the point where
MPP = APP
– TPP begins to diminish at the point where
MPP = 0 95
• To avoid such ambiguity, some
economists apply the LDR directly
to the MPP, thereby referring to
the law of diminishing marginal
returns
• In this case, the elasticity of
product substitution provides an
unambiguous way to define the
point of diminishing returns (see
the next slide)
96
 Q of
Output

MPP

APP

Q of
Input
0
Stage I Stage II Stage III
p > 1 0  p  1 p  0
p =1 p = 0 97
Therefore ....
• The point of diminishing returns
occurs at the point where MPP = APP
and p = 1
• In the classical production function,
the point of diminishing returns
occurs at the lower boundary of stage
II

98
• The lower boundary of stage II marks the point
where variable inputs are used most efficiently,
and this is where the minimum amount of
variable inputs should be used
• At the upper limit boundary of stage II:
MPP = 0, and p = 0
• Consequently, the relevant interval of production
for a variable input is within the range where:
0  p  1
99
2.6: Forms of production
functions

100
Examples:
1) Linear production functions (e.g. Y = a + bX)

2) Power (Cobb-Douglas) production functions

(e.g. Y = bXn)

3) Quadratic production functions

(e.g. Y = a + bX - cX2),

where: a, b, c and n are constants

101
4) CES functions (these have a Constant Elasticity of
Substitution): The general form of the CES production
function, with n inputs, is:
1
n r
Y  F  a i X i 
r

 i 1 

Where: Y = Quantity of output; F = Factor productivity;

ai = Share parameter of input i; Xi = Quantities of factors
of production (i = 1, 2, 3 ... n); and 1 = Elasticity of
substitution 1 r

5) Linear Programming

102
1) A linear function

For more than one variable input

103
2) Power functions (e.g. Cobb-
Douglas function)
Y = a Xb
MPP = b a Xb-1
= b a Xb X-1
Xb
 MPP  ab
X

P 
MPP


abX b 1
b

APP aX 
b 1

NOTE: Power functions can be linearized by logarithm
transformation 104
 3) Quadratic production
functions
Y = a + bX - cX 2

MPP = b – 2cX
• This kind of production function
allows for interaction between
inputs
• Example:
Y = a + b1 X1 + b2 X2 – b3 X12 – b4 X22 + b5 X1 X2 105
 Y = a + b 1 X1 + b 2 X 2 – b 3 X1 2 – b 4 X2 2 + b 5 X1 X 2

• In this case the MPP of X1 will be

influenced by X2 and vice versa

Y
MPPx1 = X 1
= b1 – 2b3 X1 + b5 X2

Y
MPPx2 = X = b2 – 2b4 X2 +b5 X1
2 106