Theory of Production

PREMIER UNIVERSITY
FACULTY OF BUSINESS STUDIES
Topic:
Theory of Production

PREPARED BY:
Sanjida Ashrafi (Ananya)
DEPARTMENT OF ACCOUNTING
PREMIER UNIVERSITY, CHITTAGONG.

Properties
of
Isoquant
1. An isoquant lying above
and to the right of another
isoquant represents a higher
level of output.
7. Each isoquant is oval-
shaped
6. Isoquants need not
be parallel
2. Two isoquants cannot
cut each other
3. Isoquants are convex
to the origin
4. No isoquant can
touch either axis
5. Isoquants are
negatively sloped

This is because of the fact
that on the higher
isoquant, we have either
more units of one factor of
production or more units of
both the factors.
1. An isoquant lying above and to the right of another
isoquant represents a higher level of output.

2. Two isoquants cannot cut each other
Just as two indifference curves
cannot cut each other, two
isoquants also cannot cur each
other. If they intersect each
other, there would be a
contradiction and we will get
inconsistent results

3. Isoquants are convex to the origin
An isoquant must always
be convex to the origin. This
is because of the operation
of the principle of
diminishing marginal rate
of technical substitution

4. No isoquant can touch either axis
If an isoquant touches the
X-axis it would mean that
the commodity can be
produced with OL units of
labor and without any unit
of capital.
Y
X

5. Isoquants are negatively sloped
An isoquant slopes
downwards from left to
right. The logic behind this
is the principle of
diminishing marginal rate
of technical substitution.
Y
X

6. Isoquants need not be parallel
The shape of an isoquant
depends upon the marginal
rate of technical substitution.
Since the rate of substitution
between two factors need not
necessarily be the same in all
the isoquant schedules, they
need not be parallel.
Y
X

An important feature
of an isoquant is that
it enables the firm to
identify the efficient
range of production.
7. Each isoquant is oval-shaped
Y
X

The term returns to scale arises in the context of a
firm's production function. It explains the behavior
of the rate of increase in output (production)
relative to the associated increase in the inputs
(the factors of production) in the long run. In the
long run all factors of production are variable and
subject to change due to a given increase in size
(scale).
Meaning of Returns to Scale

Types Of Returns To Scale
Constant
Returns To
Scale Increasing
Returns
To Scale
Decreasing
Returns To
Scale

Constant Returns To Scale
Constant returns to scale is a
potential of a production
function. A production function
exhibits constant returns to
scale if changing all inputs by a
positive proportional factor
has the effect of increasing
outputs by that factor.
Y
X

Increasing Returns To Scale
Increase in output that is
proportionally greater
than a simultaneous and
equal percentage
change in the use of all
inputs, resulting in a
decline in average costs.

Decreasing Return To Scale
Where the proportionate
increase in the inputs does not
lead to equivalent increase in
output, the output increases
at a decreasing rate, the law
of decreasing returns to scale
is said to operate. This results
in higher average cost per
unit.

Iso-Cost Line
The iso-cost line is an important
component when analyzing
producer’s behavior. The iso-cost
line illustrates all the possible
combinations of two factors that
can be used at given costs and for
a given producer’s budget. In
simple words, an iso-cost line
represents a combination of inputs
which all cost the same amount.
Y
X

The firm also maximizes its
profits by maximizing its
output, given its cost outlay and
the prices of the two factors.
This approach seems to be
more practical than the
previous one. The end result
will be the same as before.
Output Maximization For a Level Of Outlay

2. The isoquant curve must
be convex to the origin at
the point of tangency with
the isocost line.
Output Maximization for a Level Of Outlay
Conditions Of Output
Maximization
1. The firm is in equilibrium
point, where the isoquant
curve is tangent to the
isocost line .

In the theory of production, the profit
maximization firm is in equilibrium
when, given the cost- price function, it
maximizes its profits on the basis of
the least cost combination of factors.
For this, it will choose that
combination which minimizes its cost
of production for a given output. This
will be the optimal combination for it.
Least Cost Combination Of Factor

Assumption of least cost combination factor
1. There are two factors, labour and capital.
2. All units of labor and capital are homogeneous.
3. The prices of units of labor (w) and that of capital (r) are given
and constant.
4. The cost outlay is given.
7. The firm aims at profit maximization.
6. The price of the product is given and constant
5. The firm produces a single product.

Example and explanation of Cost minimization

Theory of Production

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