PRODUCTION FUNCTION

Concept of Production Function

The concept of 'production function' is the major vehicle of applied economic research
especially in the field of agricultural economics. Given that production is the process of
combining resources, both implicit and explicit, in the creation of goods or service or output,
the production function is defined as the mathematical description of the various technical
possibilities faced by a firm. It defines the maximum physical output levels obtainable from
various levels of inputs.

Generally, a production function is defined as,

Y = f (X1, X2, … ,Xn )

where Y is output, Xi are the n of inputs that determine the levels of Y, through the
mathematical relationship f. This deterministic relationship seldom holds in practice due to
other, usually unobserved, variable inputs referred as random effects represented as u.
Adding the term u to (2.1) modifies it to a probabilistic expression,

Y = f (X1, X2,… ,Xn ) + u

Though expression (2.2) is relevant for practical applications, from an economist's point of
view, expression (2.1) is taken as the basis for exposing economic principles, the analysis of
which starts usually with a single input, keeping all other variables constant,

Y = f (X1 | X2, …, Xn )

Relationship production function-

1. Input-output relationship- Y = f (X1 , X2, …, Xn )

Where Y is output , Xi, i= 1,2,… , n are the levels of input that determine the levels of
Y, through the mathematical relationship f.

2. Factor-Factor relationship- Q* = f (X1 , X2)

Where Q* is fixed level of output and X1 and X2 are the quantities of variable inputs.

3. Product-Product relationship- Y1 = f (Y2, Y3, Y4… Yn)

Where this expression reveals that a farmer is having an option of growing four or more
crops in the same season in his operational holding. Then acreages proposed to be allocated
under crop Y1 is a function of acreage under crops Y2, Y3, Y4 and Yn.

Single variable production function:

The production function for a single variable input and output is specified as
Q = f (X1 | X2, …, Xn )

Here, X1 is variable input, X2, …, Xn are fixed inputs and Q is output.

Average product of X1 is defined as

AP1 = Q/ X1

Due to the operation of the law of diminishing returns, AP1 must decreases as X1 increases

Marginal product of X1 - MP1 = dQ/dX1

Elasticity of X1 input
𝑑𝑄 dx1
E1 = /
𝑄 𝑥1

𝑑𝑄 𝑑𝑄
E1 = 𝑑𝑥1 == 𝑑𝑥1
x1 x1
𝑄 𝑄

Elasticity of production (Ep) = MP1 / AP11

Productions function with two variable inputs:

The estimated production function with two variable X1 and X2 is given as

Q = 21.27 + 10.3X1 + 4.3X2 – 0.32X12 - 0.44X22 + 0.13X1X2

This is second degree polynomial response function with two variable

MP1 and MP2 are estimated for the given equation

MP1 = 𝜕Q/𝜕X1 = 0 + 10.3 – 0.64 X1 + 0.13 X2

MP2 =𝜕 Q/𝜕X1 = 0 + 4.3 – 0.88 X2 + 0.13 X1

To get maximum profit, MP1 and MP2 should be equated with their respective price ratio.

10.3 – 0.64 X1 + 0.13 X2 = P1/Pq

4.3 – 0.88 X2 + 0.13 X1 = P2/Pq

LINEAR HOMOGENEOUS PRODUCTION FUNCTION

Production function can take several forms but a particular form of production
function enjoys wide popularity among the economist. This is the homogeneous production
function, that is, production function which is homogeneous of the first degree.
Homogeneous production function of the first degree implies that if all factor of production
are increases in given proportion, output also increases in the same proportion. Hence linear
homogeneous production function represents the case of constant return to scale. If there are
two factors X and Y, then homogeneous production function of the first degree can be
mathematically expressed as:

mQ = f(mX, mY)

where Q stands for the total production and m is any real number. The above
function means that if factors X and Y are increased by m-times, total production Q also
increases by m-times. It is because of this that homogeneous function of the first degree
yields constant return to scale.

Assumption of production function analysis

Following are the important assumption of production function analysis:

1. The production function is defined only for non-negative values of inputs and outputs, in
term of, this mean that

y≥0

xi ≥ 0 i = 1, 2, … n

2. Every possible combination of inputs is assumed to result in maximum level of output.

This means that the production function presupposes technical efficiency.

3. The input output relationship or the production function is single value and continuous for
which there exist first and second order partial derivatives of the output , Y, w.r.t. each of the
inputs variable, x1, x2, …, x1, i.e. , ᵊy/ᵊxi and ᵊ2 y/ᵊx2i (i = 1, 2, . . . ,l ) are non-vanishing.

4. The production function is the characterized by (a) decreasing marginal product for all
factor-product combination , (b) decreasing rate of technical substitution between two any
factor, and (c) an increasing rate of product transformation between any two products.
𝜕2𝑦
Mathematically, this corresponds to : < 0, 𝑖 = 1,2,3, … , 𝑙
𝜕𝑥2𝑖

𝑑2𝑥𝑖
< 0, 𝑖, 𝑗 = 1,2,3, … , 𝑙(𝑖 ≠ 𝑗)
𝑑𝑥2𝑗

𝑑2𝑦𝑖
< 0, 𝑖 , 𝑗 = 1,2,3, … , 𝑚 ( 𝑖 ≠ 𝑗)
𝑑𝑦2𝑗

Interpreted differently, condition equation respectively require a concave production

function to the input axis, convex isoquants, and concave product transformation curve to the
origin. Thus we do not include cases of increasing and constant return. However , it is a
common experience in agricultural production that as the level of input x1 is increased, it
results in increasing, constant and decreasing to sequence. Nevertheless, under usual
condition, the existence of diminishing return to individual input variable is most likely.

5. The return to scale are assumed to be decreasing. This means that simultaneous one per
cent increasing the all inputs result in less than one per cent increasing in the output. In other
word, doubling of all inputs less than double the output. Mathematically, this assumption can
𝑥1 𝜕𝑦
be stated as ∑( 𝑦 ) (𝜕𝑥1) < 1, 𝑖 = 1, 2, … , 𝑙

6. The exact nature of the farms production function is assumed to be determined by a set of
technical decision taken by the producer.

7. All the products and factor of production are perfectly divisible.

8. The parameters determining the firm’s production function do not change over the time
period considered. Besides, these parameters are not permitted to be random variables.

The method of production function analysis immediately breaks down if one or more
of foregoing assumptions (1-8) do not held.