Assignment On

Chapter 3:
Theory of Firm

Chapter:3
Name Registration Contribution

Musaddik Billah 2018234038

Sanjida Tajrin 2018234032

Amirul islam 2018234016

Ibrahim Adham 2018234009

Arafat Mallick 2017234017

Riya Roy 2017234019

 Chapter 3: Theory of Firm

3.1 : Production Function.

3.1.1 : Factors of production.

3.1.2 : SR LR production Function.

3.2 : Total, Average, Marginal Production Curve.

3.2.1 : Relationship Between TP, AP, MP.

3.2.2 : Law of Diminishing Returns.

3.2.3 : Stage of Production.

3.3 : LR Production Function.

3.3.1 : IQ and Iso-cost Curve.

3.3.2 : Production Equilibrium.

3.3.3 : Expansion Path.

3.4 : SR LR Cost Curve.

3.4.1 : SR Cost Curve.

3.4.2 : LR Cost Curve.

3.4.3 : Relationship Between all SR and LR.

 Theory of Firm
3.1. Production Function Production:
Production means making something. In economics, production means creation or addition of
utility or value. So, we can say that, production is the activity of transformation of inputs into
outputs. Outputs are the amount of goods and services produced by firm.
Production Function: Production function depicts the technical relationship between inputs and
outputs.

3.1.1. Factors of Production:

Factors of production are goods and services which are used to produce other goods and
services.

They are classified into 4 categories :

1.Land (La)
2.Labor(L)
3.Capital (K)
4.Organization (O)

1.Land (La):
Land means all-natural resources used in the production process, such as land, forests, oil, air,
water etc.
2.Labor(L):
Labor means physical and intellectual efforts of individual used in producing goods and services.
Like, the services of a farmer, doctor, teacher etc. all are "labor".
3.Capital (K):
Capital is produced means of production. Like, tools, machineries, skills etc.
4.Organization (O):

It is also known as "entrepreneurship". Entrepreneurship refers to the talent that some people
have for organizing the resources of land, labor and capital to produce goodsSymbolically,
output = f(input) q=f(La,L,K,O) For analytical convenience,

"land" as "natural capital " and merged "entrepreneurship" under "organizational or institutional
capital", and simply, the production function in two- dimensions: q=f(L,K)

3.1.2. SR vs LR Production Function

1. Short run refers to the period of time when at least one of the factors of production remains
fixed. And, long run refers to the period of time during which all inputs used in a production
process become variable.

2. In SR, an input whose use varies with changes (increase or decrease ) with output is called
variable input and which input doesn't change with output is called fixed input. In LR, all inputs
are changes with output and all of these are variable input.

3. In SR, q=f(L,K) ectara. [Here, L is variable but K is fixed ] And in LR, q=f(L,K) [Here, both
L and K are variable]
3.2. Total, average and marginal product curve

Total product: We can define total product as total volume or amount of final output produced
by a firm using given input in a given period of time.

Average product: It is defined as the output per unit of factor inputs or the average of the total
product per unit of input and can be calculated by dividing the total product by the inputs.

Marginal product: The additional output produced as a result of employing an additional unit of
variable factor is called the marginal product.
3.2.1. Relationship between TP, AP, MP

TP vs MP
1. MP is increasing when TP is increasing at increasing rate.
2. MP is at maximum when TP is at the point of inflection.
3. MP is declining when TP is increasing at decreasing rate.
4. MP=0 when TP is at maximum.
5. MP<0 when TP is decreasing.

TP vs AP
1. AP is maximum at the point where a ray from the origin is tangent to TP.

AP vs MP
1. MP crosses at the AP maximum from above.
2. AP is less than MP before AP maximum.
3. AP>MP after MP maximum.

3.2.2 Low of diminishing Returns:

Law of diminishing returns explain that when more and more units are employed on give
quantity of fixed input ,the total output may initially increase at increasing rate and then at a
constant rate ,but it eventually increase at diminishing rates.
In other words ,the total output initially increases with an increase in variable input at given
quantity of fixed input,But it starts Decreasing after a point of time.

Example
The following table shows the total product, the average product and the marginal product of a firm
operating in the short-term. The variable factor is the labor.
1. When the marginal product increases, the total product grows by the same amount. (L=1, MP
=10, TP=10, L=2, MP=24, TP=24).

2. At the point where the marginal product reaches its maximum value (L=2, MP=24), the total
product starts to increase at a decreasing rate. That is, the law of diminishing returns comes into
effect after adding an additional unit of labor (L=3).

3. When the marginal product is equal to 0, the total product takes the maximum value (TP=48).

4. When the marginal product is negative, the total product decreases (TP=47).

5. When the marginal product is equal to or higher than the average product, the average product
increases as the variable factor increases (L=1, L=2).

6. When the marginal product is equal to or lower than the average product, the average product
decreases as the variable factor increases (L=3 to L=7).
3.2.3 : Stage of Production:
There are three stage of Production

The three stages of production are characterized by the slopes, shapes, and interrelationships of the total,
marginal, and average product curves. ... In Stage I, average product is positive and increasing.
In Stage II, marginal product is positive, but decreasing. And in Stage III, total product is decreasing.

3.3. LR production function

LR production function is the relationship between input and output that explained under the
condition when both labor and capital are variable inputs.

LR: q = f (L, K)
Here, q is constant and L, K is variable.
 L K MRTS
A1 10
B2 5 5
C3 3 2
D4 2 1
E5 1 1

3.3.1. Isoquant and Iso cost curve Isoquants (IQ):

Isoquants are the curves, which represent the different combinations of inputs producing a
particular quantity of output. In this curve, we can see it is convex.Because diminishing level is
declining and MRTS is alo decreasing. Because the quantity number is same. For different
number or every combination of graph give the same level of production.

Properties of IQ:
1. IQ is downward sloping. Because the relation is negative. One is increasing and one is
decreasing.
2. IQ convex to the origin.
3. IQs are parallel to each other. No two IQs are intersect.
4. Higher level of IQ gives higher level of production.
5. Point on the IQ gives same level of production.
*Isoquant Map

An isoquant map shows the different level of output. For example, IQ1 show the combinations of
capital and labor that can produce 10 amount of product. IQ2 and IQ3 we can see higher output
than IQ1.
Isocost : Isocosts refer to that cost curve that represents the combination of inputs that will cost
the producer the same amount of money. An isocost shows all the combination of factors that
cost the same to enjoy.

In this curve, there are three downwards sloping straight live cost curves. Each isocost denotes a
particular level of total cost for a given level of production. If the given level of production
changes, the total cost changes and thus the isocost curve moves upwards and vice versa.

3.3.2. Producers equilibrium

Equilibrium refers to a state of rest when no change is required. A firm (producer) is said to be in
equilibrium when it has no inclination to expand or to contract its output. This state either
reflects maximum profits or minimum losses.

Among 3 efficient point, one is candidate for equilibrium. Because one is tangential.
1. Isocost should be tangential to IQ.
2. Point R and S are not tangential but intersecting point.

3.3.3. Expansion Path

 Expansion path is that line which reflects the least cost method of producing different levels of
output, when factor prices remain constant.

In this diagram ,the convex curves are isoquants and each showing various combinations of input
usages that would give the particular output level designated by the particular isoquant and all
slopes are equal . Tangency points show the lowest cost input combination for producing any
given level of output. A curve connecting the tangency points is called the expansion path
because it shows how input usages expand as the chosen level of output expands.
Here we can find, locus of all equilibrium points at various levels of production.
Mathematically

3.4. SR cost curves

A short-run cost curve shows the minimum cost impact of output changes for a specific plant and
in a given operating environment. Such curves reflect the optimal or least-cost input combination
for producing output under fixed circumstances. size

--------image--------

3.4.1 LR cost curve:

The long-run cost curve is a cost function that models this minimum cost over time, meaning inputs are
not fixed.
--------image---------

TC vs MC
1. TC is at first increasing at decreasing rate and then increasing at increasing rate.
2. MC is decreasing when TC is increasing at decreasing rate.
3. MC is maximum when TC is at the point of inflection.
4. MC is increasing when TC is increasing at increasing rate.

TC vs AC
1. When TC is increasing at decreasing rate AC is first falling, then reaches it minimum and then
rising.
2. AC is minimum when TC is tangential to the ray from the origin.
3. Before AC minimum AC is decreasing and after AC minimum AC is increasing.

TC vs AVC
1. When TC is increasing at decreasing rate AVC is first falling, then reaches it minimum and
then rising.
2. AVC is minimum when TC is tangential to the ray from the origin.
3. Before AVC minimum AVC is decreasing and after AVC minimum AVC is increasing.

TC, AVC vs MC
1. MC curve intersect both AC and AVC through the minimum of AC and AVC from bellow

3.4.2. Relationship between all SR and LR cost curves.

1. SRTC vs LRTC => Locus of SRTC curves with their tangential points. => LRTC is envelope
of SRTCs.
2. SRAC vs LRAC => At LRAC minimum, SRAC is tangential to LRAC at minimum point.
=>When LRAC falling, SRAC is tangential to LRAC to the left of SRAC minimum. =>When
LRAC is rising, SRAC is tangential to LRAC to the right of SRAC minimum.
3. LRAC vs LRMC => LRMC is intersecting LRMC through the minimum point from the
bellow.