Course: BBASubject: Business Economics

Unit: 5

Theory of Production

Syllabus content

• Rent: Concepts of Differential Rent and Scarcity Rent, Economic and Contract Rent, Quasi Rent and Pure Rent

• Wages: Concepts of Time Wages, Piece Wages, and Money wages, real Wages and factors determining real Wages.

• Production: Meaning and Concept of Production, Factors of Production and Production function, Fixed and Variable Factors, Law of Variable Proportion (Short Run Production Analysis), Law of Returns to a Scale (Long Run Production Analysis) through the use of ISO QUANTS.

Some Basic Concepts

1. Production: It is a process where inputs are converted into output.

2. Input : It is anything which is used to produce goods or service.

3. Output: It is final goods or services produced after process on input

4. Fixed Factors: The supply of the factors is constant in short run. Those factors are called as fixed factors

5. Variable Factors: The supply of the factors changes in long run. Those factors are called as variable factors.

Factors of Production

What Is Production Function ?

• The relationship between the inputs and the resulting output is described as production function in Economics.

• A production function shows the relationship between the amounts of factors used and the amount of output generated per period of time.

Production Function

Short term : Time when one input (say, capital) remains constant and an addition to output can be obtained only by using more labour.

Long run: Both inputs become variable.

Law of Variable Proportions

Law of Variable Proportions (Short run Law of Production)

Assumptions:

• One factor (say, L) is variable and the other factor (say, K) is constant

• Labour is homogeneous

• Technology remains constant

• Input prices are constant in the time under consideration

Law of Returns to a Scale

• Also called as production function in long run

– X= f (L,K)

– In long run ‘L’ and ‘K’ are variable

– This law shows various combinations of ‘L’ and ‘K’

– The graph is called as isoquants

• Assumptions:

– There are only two factors of production

– Technology does not change

– Continuity in production

Isoquant Map• More than one isoquants depicted in one

graph is called isoquant map

Characteristics of Isoquants

• Isoquant slope downward to the right

• Isoquant are always convex to the origin

• Isoquant can never intersect each other

Differential Rent And Scarcity rent

• Differential Rent means that the investor who produces wheat on the more productive lands reaps an extra-profit or rent on that land.

• Scarcity rent is the cost of "using up" a finite resource because benefits of the extracted resource are unavailable to future generations.

Economic and Contract Rent

• Economic rent is the difference between what an owner of a factor of production (such as land, capital or labor) receives and the opportunity cost for that owner.

• Contract Rent is the amount of total contractual payment made by the tenant to the landlord according to the agreement

Quasi Rent and Pure Rent

• Quasi rent means when one makes an investment and pays for it, and then earns income from it without needing to make further investment.

• Pure Rent means income received from the use of a resource whose supply, in the long run, is totally unresponsive to its price because it can neither be produced nor destroyed by its consumers.

Wages

• The Wage = "price of labor”

• Time Wages: The wages paid according to the hours of working.

• Piece Wages: The wages paid according to number of products produced.

• Money Wages: The wages received in terms of money.

• Real Wages: The wages with real value.

Factors determining Real Wages

• Price level:Money wage remaining constant, Real wage = Money Wage divided by Price level. Higher the price level, lower will be the real wage and vice versa.

• Money wages:If the price level remains constant and the money wages increase then real wage also increases. But if the rise in price level is higher than the rise in money income, then the real income would fall.

• Fringe benefits:Cash-in-kind or fringe benefits or perks like free accommodation facilities, free transport, medical reimbursement, subsidized food from canteen etc. increase the real wage of a worker.

Factors determining Real Wages

• Nature of job:In a risky and dangerous jobs, money wage may be higher but real wages are low. For example workers in mines. The real wage of workers in a regular job is higher than those in an irregular job.

• Scope for extra earnings:In jobs where there is a possibility of extra earnings the real wage would be high.

• Future prospects:In jobs if future prospects like quick promotion and higher earnings are possible then the real wage would be high.