FACTORS OF PRODUCTION AND PRODUCTION FUNCTION

Production Function: Meaning, Definitions and Features

Production is the result of co-operation of four factors of production viz., land, labour, capital and organization. This is evident from the fact that no single commodity can be produced without the help of any one of these four factors of production. The term ‘Factors of Production’ refers to those goods & services which helps in th e process of production. There are four factors of production, Land, Labour, Capital, Organisation.

(a) Land: As per Prof Marshall, “By land is meant not merely land in the strict sense of the word, but the whole of the material & forces which nature gives us freely for man aid in land, water, air, light & heat”. Thus land is defined as a primary factor which includes besides physical territory, all natural resources such as water, sunshine, rainfall, wind, sea, river, air, heat, light, minerals etc, where some part can be under control of human & large factors are beyond human control.  It refers to all natural resources. All natural resources either on the surface of the earth or below the surface of the earth or above the surface of the earth is Land. One uses the land to produces goods. It is the primary and natural factor of production. All gifts of nature such as rivers, oceans, land, climate, mountains, mines, forests etc. are land. The payment for land is rent.

Characteristics of Land as a Factor of Production

• The land is a free gift of nature.
• The land has no cost of production.
• It is immobile.
• The land is fixed and limited in supply.

 (b) Labour:  Labour means physical or mental effort exerted for the purpose of producing a commodity or a service. It is only human labour that is considered in this context.  All human effort that assists in production is labour. This effort can be mental or physical. It is a human factor of production. It is the worker who applies their efforts, abilities, and skills to produce. The payment for labour is the wage.

Characteristic of Labour as a Factor of Production

• It is a human factor.
• One cannot store labour.
• No two types of labour are the same.

Types of Labor

1. Unskilled
2. Semi-skilled
3. Skilled
4. Professional

(c) Capital: Capital is produced means of production. There are two important points:

First – It is produced by man & is not a gift of nature,

Second– It is means of production, i.e., it is used as an input in producing other goods. It is not directly consumed.

(i) Wealth & Capital: Wealth can be used both as an input in the production process & as a consumer goods. Thus, all capital goods are parts of society’s total wealth, but wealth is not necessary capital.

(ii) Capital & Income: Capital is a stock. At a certain point of time a person has a certain amount of capital. Income, however is a flow because it has a time dimension. A person earns Income by investing capital, i.e., by using the capital in the production process. Example of Capital: (1) All raw materials of productions are capital, because these have been produced else where. (2) A building is not a capital if it is used for private housing. But it is capital if it is used for productive purposes (a factory building). (3) Money kept in the form of bank deposits is capital. The bank lends the money to producer’s who use it as capital. 

Capital refers to all manmade resources used in the production process. It is a produced factor of production. It includes factories, machinery, tools, equipment, raw materials, wealth etc. The payment for capital is interest.

Characteristics

• Capital is a manmade factor of production.
• It is mobile.
• It is a passive factor of production.

Types of Capital

1. Fixed
2. Working
3. Venture

(d) Organisation or Entrepreneur :By organisation we mean the services performed by the entrepreneurs. The entrepreneurs coordinate the activities of the agents of production i.e, land, labour& capital. They also bear the risk of business. If the outputs sold in the market bring in a profit, it is the entrepreneurs who get it. But if there is a loss, it is again, the entrepreneurs who have to bear such loss.

Therefore, the producer combines all the four factors of production in a technical proportion. The aim of the producer is to maximize his profit. For this sake, he decides to maximize the production at minimum cost by means of the best combination of factors of production. The producer secures the best combination by applying the principles of equi-marginal returns and substitution. According to the principle of equi-marginal returns, any producer can have maximum production only when the marginal returns of all the factors of production are equal to one another. For instance, when the marginal product of the land is equal to that of labour, capital and organisation, the production becomes maximum.

An entrepreneur is a person who brings other factors of production in one place. He uses them for the production process. He is the person who decides

• What to produce
• Where to produce
• How to produce

A person who takes these decisions along with the associated risk is an entrepreneur. The payment for land is profit.

Characteristics

• He has imagination.
• He has great administrative power.
• An entrepreneur must be a man of action.
• An entrepreneur must have the ability to organize.
• He should be a knowledgeable person.
• He must have a professional approach.

Other potential factors of production

(e) Knowledge – human capital – the skills and ability of workers. For example, a doctor who spent 15 years studying medicine is more productive than non-skilled workers.

(f) State of technology – some schools of economics consider the state of technological development to be a factor of production. It will influence the effectiveness of capital investment.

(g) Social capital – the coherence of society. Is there trust and working legal systems which enable entrepreneurs to have greater faith in setting up a business

(h) Cultural heritage – if there is a strong tradition of investment and business, it is easier to replicate past business models.

PRODUCTION FUNCTION

The production function simply states the quantity of output (q) that a firm can produce as a function of the quantity of inputs to production. There can be a number of different inputs to production, i.e, "factors of production", but they are generally designated as either capital or labor. (Technically, land is a third category of factors of production, but it's not generally included in the production function except in the context of a land-intensive business.) The particular functional form of the production function (i.e. the specific definition of f) depends on the specific technology and production processes that a firm uses.

Meaning of Production Function:

In simple words, production function refers to the functional relationship between the quantity of a good produced (output) and factors of production (inputs). “The production function is purely a technical relation which connects factor inputs and output.” Prof. Koutsoyiannis.

Defined production function as “the relation between a firm’s physical production (output) and the material factors of production (inputs).” Prof. Watson

In this way, production function reflects how much output we can expect if we have so much of labour and so much of capital as well as of labour etc. In other words, we can say that production function is an indicator of the physical relationship between the inputs and output of a firm. The reason behind physical relationship is that money prices do not appear in it. However, here one thing that becomes most important to quote is that like demand function a production function is for a definite period. It shows the flow of inputs resulting into a flow of output during some time. The production function of a firm depends on the state of technology. With every development in technology the production function of the firm undergoes a change. The new production function brought about by developing technology displays same inputs and more output or the same output with lesser inputs. Sometimes a new production function of the firm may be adverse as it takes more inputs to produce the same output.

Mathematically, such a basic relationship between inputs and outputs may be expressed as:

Q = f( L, K, N )

Where Q = Quantity of output

L = Labour

K = Capital

N = Land.

Hence, the level of output (Q), depends on the quantities of different inputs (L, K, N) available to the firm. In the simplest case, where there are only two inputs, labour (L) and capital (K) and one output (Q), the production function becomes.

Q =f (L, K)

Definitions:

“The production function is a technical or engineering relation between input and output. As long as the natural laws of technology remain unchanged, the production function remains unchanged.” Prof. L.R. Klein.

“Production function is the relationship between inputs of productive services per unit of time and outputs of product per unit of time.” Prof. George J. Stigler

“The relationship between inputs and outputs is summarized in what is called the production function. This is a technological relation showing for a given state of technological knowledge how much can be produced with given amounts of inputs.” Prof. Richard J. Lipsey

Thus, from the above definitions, we can conclude that production function shows for a given state of technological knowledge, the relation between physical quantities of inputs and outputs achieved per period of time.

Features of Production Function:

Following are the main features of production function:

1. Substitutability:

The factors of production or inputs are substitutes of one another which make it possible to vary the total output by changing the quantity of one or a few inputs, while the quantities of all other inputs are held constant. It is the substitutability of the factors of production that gives rise to the laws of variable proportions.

2. Complementarity:

The factors of production are also complementary to one another, that is, the two or more inputs are to be used together as nothing will be produced if the quantity of either of the inputs used in the production process is zero. The principles of returns to scale is another manifestation of complementarity of inputs as it reveals that the quantity of all inputs are to be increased simultaneously in order to attain a higher scale of total output.

3. Specificity:

It reveals that the inputs are specific to the production of a particular product. Machines and equipment’s, specialized workers and raw materials are a few examples of the specificity of factors of production. The specificity may not be complete as factors may be used for production of other commodities too. This reveals that in the production process none of the factors can be ignored and in some cases ignorance to even slightest  extent is not possible if the factors are perfectly specific. Production involves time; hence, the way the inputs are combined is determined to a large extent by the time period under consideration. The greater the time period, the greater the freedom the producer has to vary the quantities of various inputs used in the production process. In the production function, variation in total output by varying the quantities of all inputs is possible only in the long run whereas the variation in total output by varying the quantity of single input may be possible even in the short run.

In the short run the amount of capital that a factory uses is generally thought to be fixed. (The reasoning is that firms must commit to a particular size of factory, office, etc. and can't easily change these decisions without a long planning period.) Therefore, the quantity of labor (L) is the only input in the short-run production function. In the long run, on the other hand, a firm has the planning horizon necessary to change not only the number of workers but the amount of capital as well, since it can move to a different size factory, office, etc. Therefore, the long-run production function has two inputs that be changed- capital (K) and labor (L).  The quantity of labor can take on a number of different units- worker-hours, worker-days, etc. The amount of capital is somewhat ambiguous in terms of units, since not all capital is equivalent, and no one wants to count a hammer the same as a forklift, for example. Therefore, the units that are appropriate for the quantity of capital will depend on the specific business and production function.

The Production Function in the Short Run

Because there is only one input (labor) to the short-run production function, it's pretty straightforward to depict the short-run production function graphically. As shown in the above diagram, the short-run production function puts the quantity of labor (L) on the horizontal axis (since it's the independent variable) and the quantity of output (q) on the vertical axis (since it's the dependent variable).

The short-run production function has two notable features. First, the curve starts at the origin, which represents the observation that the quantity of output pretty much has to be zero if the firm hires zero workers. (With zero workers, there isn't even a guy to flip a switch to turn on the machines!) Second, the production function gets flatter as the amount of labor increases, resulting in a shape that is curved downward. Short-run production functions typically exhibit a shape like this due to the phenomenon of diminishing mariginal producr of labor. In general, the short-run production function slopes upwards, but it is possible for it to slope downwards if adding a worker causes him to get in everyone else's way enough such that output decreases as a result.

The Production Function in the Long Run

Because it has two inputs, the long-run production function is a bit more challenging to draw. One mathematical solution would be to construct a three-dimensional graph, but that is actually more complicated than is necessary. Instead, economists visualize the long-run production function on a 2-dimensional diagram by making the inputs to the production function the axes of the graph, as shown above. Technically, it doesn't matter which input goes on which axis, but it is typical to put capital (K) on the vertical axis and labor (L) on the horizontal axis.

this graph as a topographical map of quantity, with each line on the graph representing a particular quantity of output. (This may seem like a familiar concept if you have already studied indifference curve). In fact, each line on this graph is called an "isoquant" curve, so even the term itself has its roots in "same" and "quantity." (These curves are also crucial to the principle of cost minimization). 

In the long run, there are often a number of different ways to get a particular quantity of output. If one were making sweaters, for example, one could choose to either hire a bunch of knitting grandmas or rent some mechanized knitting looms. Both approaches would make sweaters perfectly fine, but the first approach entails a lot of labor and not much capital (i.e. is labor intensive), while the second requires a lot of capital but not much labor (i.e. is capital intensive). On the graph, the labor-heavy processes are represented by the points toward the bottom right of the curves, and the capital heavy processes are represented by the points toward the upper left of the curves.

In general, curves that are further away from the origin correspond to larger quantities of output. (In the diagram above, this implies that q3 is greater than q2, which is greater than q1.) This is simply because curves that are further away from the origin are using more of both capital and labor in each production configuration. It is typical (but not necessary) for the curves to be shaped like the ones above, as this shape reflects the tradeoffs between capital and labor that are present in many production processes.