PRODUCER BEHAVIOUR

AND SUPPLY
 It shows the functional relation between physical inputs
and physical output of a good.

It can be expressed as Q =f (i1, i2, i3……… in).

Production Q = f (L,K)
Function
Where Q = Physical output of a good; i1, i2, i3, …….in=
Physical inputs.
L= Labour and K= capital
Production is creation of utility.
 There are two types of Production Function.
 Short-run Production Function :
• In this production function one factor of production
is variable and all others are fixed.
Types of •So, law of return to a factor is applied. It is also called
Production variable proportion type of production function.
•It is a time period which is not enough to make
Function change in all inputs.
•In this level of production can be changed by
changing the variable factors.
• Long-run Production Function:
• In this production function all the factors of
production are variable.
•So, law of returns to scale is applied. It is also called
constant proportion type of production function.
•It is a time period which is enough to make change in
all inputs, all inputs are variable in the long run.
• In this level of production can be changed by
changing all inputs.
Total product • Total product refers to total
quantity of a goods produced by

or Total a firm in a given period of time

with given number of inputs.

physical • Total product can also be

calculated as the sum of

product marginal product.

• TP = ∑MP
• TPn = MP1 +MP2 + MP3 + …….
MPn
• TP in terms of AP will be as
follows:
• TP = AP X Units of Variable
Factor
Total
Product
Average product or
Average Physical
Product

• Average product refers to output per unit

of variable input.
 • Marginal product refers to the
change in total product

Marginal resulting from the employment

of an additional unit of variable
factor.
Product • In other words, it is the
contribution of each additional
unit of variable factor to output.
• MP = ΔTP/ΔL
• MPn = TPn – TP n-1
Relation
between
Total and  When TP increases at an increasing
rate, MP also increases.
Marginal
Product  When TP increases at a diminishing
rate, MP declines.
 When TP is maximum, MP=0.
 When TP begins to decline, MP becomes
negative.
Total, Average and
Marginal Product
Relation between Marginal Product
and Average Product
• When MP > AP, AP rises.
• When MP = AP, AP is maximum and constant.
• When MP < AP, AP falls.
• MP may be zero or negative, but AP continues to be positive.
Labour MP TP AP

1 2 2 2

2 3 5 2.5

3 4 9 3

4 3 12 3

5 1 13 2.6

6 0 13 2.16

7 -2 11 1.6
Returns to • Returns to a factor : It
a factor refers to the behaviour of
output when only one
variable factor of
production in increased in
short run and fixed factors
remain constant.
Law of variable
proportion
• Law of variable proportion :
•  The law states that when more and
more units of variable factors are
employed to increase the output,
initially output increases at an
increasing rate, then at a decreasing
rate and finally at a negative rate
(falls).
Assumptions

• It operates in short run, as factors are classified as variable and fixed factor
• The law applies to all fixed factors including land
• Under law of variable proportions, different units of variable factor can be
combined with fixed factor
• This law applies to the field of production only
• The state of technology is assumed to be constant during the operation of this law
• It is assumed that all variable factors are equally efficient
• It is assumed that factors of production become imperfect substitutes of each other
beyond a certain limit
 • Stage I (Stage of Increasing Return to
Stage I factor):
(Stage of •  TP Increases at increasing rate : In
the initial phase as more and more
Increasing units of variable factors are
Return to employed with fixed factor,total
physical product(TP) increases at
factor) increasing rate, MP increases.
• Cause for increasing return: 
• (a) Better utilisation of fixed factor
• (b) Indivisibility of factor
• (c) Increased efficiency of variable
factor
• Better Utilization of the Fixed Factor:
• The supply of the fixed factor (say, land) is too large, whereas variable factors are too few.
• So, the fixed factor is not fully utilised. When variable factors are increased and combined with fixed factor, then fixed factor is
better utilised and output increases at an increasing rate.
• Increased Efficiency of Variable Factor:
• When variable factors are increased and combined with the fixed factor, then former is utilised in a more efficient manner.
• At the same time, there is greater cooperation and high degree of specialization between different units of the variable factor.
• Indivisibility of Fixed Factor:
• The fixed factors which are combined with variable factors are indivisible and cannot be divided into smaller units.
• Once an investment is made in an indivisible fixed factor, then addition of more and more units of variable factor, improves the
utilisation of fixed factor.
• The increasing returns apply as long as optimum level of combination between variable and fixed factor is achieved.
 • Stage II(Stage of
Stage Diminishing Return to
factor) :

II(Stage of
•  TP increases at
decreasing rate :As more
and more units of
Diminishing variable factors are
employed with fixed

Return to
factors then total
product increases at
diminishing rate, MP

factor)  decreases but is positive.

At the end of this phase
TP maximum and MP
becomes zero.
• Cause of diminishing
return:
•  (a) optimal(optimum)
use of fixed factor
• (b) imperfect factor
substitutability(imperfec
t substitutes)
• Optimum Combination of Factors:
• Among the different combinations between variable and fixed factor, there is one optimum combination, at
which total product (TP) is maximum.
• After making the optimum use of fixed factor, the marginal return of variable factor begins to diminish.
• For example, if a machinery (fixed factor) is at its optimum use, when 4 labours are employed, then addition of
one more labour will increase TP by very less amount and MP will start diminishing.
• 2. Imperfect Substitutes:
• Diminishing returns to a factor occurs because fixed and variable factors are imperfect substitutes of one
another. There is a limit to the extent of which one factor of production can be substituted for another.
• For example, labour can be substituted in place of capital or capital can be substituted in place of labour till a
particular limit. But, beyond the optimum limit, they become imperfect substitutes of one another, which leads
to diminishing returns.
 • Stage III(Stage of negative return to
Stage factor) :
III(Stage •  TP falls :As more and more units of
of variable factors are employed with
fixed factors; total production starts
Negative decreasing and marginal product
Return to becomes negative.
• Cause of negative return: 
factor) • (a) Poor co-ordination between fixed
factor and variable factor.
• (b) Over utilisation of fixed factor
• ( c ) Decrease in Efficiency of Variable
Factor
 
• Limitation of Fixed Factor:
• The negative returns to a factor apply because some factors of production are of fixed nature, which cannot be
increased with increase in variable factor in the short run.
• Poor Coordination between Variable and Fixed Factor:
• When variable factor becomes too excessive in relation to fixed factor, then they obstruct each other.
• It leads to poor coordination between variable and fixed factor. As a result, total output falls instead of rising and
marginal product becomes negative.
• Decrease in Efficiency of Variable Factor:
• With continuous increase in variable factor, the advantages of specialization and division of labour start
diminishing.
• It results in inefficiencies of variable factor, which is another reason for the negative returns to eventually set in.
• Law of Variable Proportions is an extension of another famous law, known as ‘Law of Diminishing Returns’.
 Economic Cost :
•  It is the sum total of explicit and implicit cost.
Explicit Cost :
Economic •  Actual money expenditure incurred by a firm
on the purchase and hiring the factor inputs
Cost for the production is called explicit cost.
• These are entered into books of accounts. For
example-payment of wages, rent, interest,
 purchases of raw materials etc.
 Implicit cost 
• It is the cost of self owned resources of the
production used in production process. Or
estimated value of inputs supplied by owner
itself. These are not entered into books of
accounts.
•  
Normal • Normal Profit : It is the minimum
Profit  amount required to keep the producers
into business. In other words, it is the
minimum supply price of the
entrepreneur. It is also called the wage
of an entrepreneur.
 •Total cost 
•It refers to total amount of money which is incurred by a firm on
production of a given amount of a commodity.
•Total cost is the sum of total fixed cost and total variable cost.

Cost •TC = TFC + TVC or TC = AC × Q

•Total fixed cost:-

•It is also called supplementary cost. It is the total expenditure

incurred by the producer for employing fixed inputs.  Ex- Rent of
land and building, interest on capital,license fee etc.
•TFC = TC – TVC or TFC = AFC × Q

•Features of Total Fixed Cost:-

• (a) It remains constant at all levels of output. It is not zero even at
zero output level. Therefore, TFC curve is parallel to X-axis.
•(b) Total cost at zero level of output is equal to total fixed cost.
 •Total variable cost:
•It  is the cost incurred on variable input
•It varies with the quantity of output produced.
Total • It is zero at zero level of output.
•TVC curve is parallel to TC curve.
Variable •Example : cost of raw material, expenses on power
etc.
Cost •TVC = TC – TFC or TVC = AVC × Q
 
•Features of Total variable cost:-
• (a) It is zero when output is zero.
• (b) It increases with increase in output.
•(c) Initially TVC increases at diminishing rate due to
increasing returns and later it increases at an
increasing rate due to diminishing return. 
Average • Average cost:
Cost • It is per unit cost of production of a commodity.
It is the sum of average fixed cost and average
variable cost.
• AC = TC/Q AC = AFC + AVC
 • Average fixed cost :
• It is per unit fixed cost of production of a
commodity.
• AFC = TFC/Q
• AFC =AC-AVC

Average fixed cost

•Features of AFC:-
•(a) AFC diminishes with increase in output.
•(b) AFC curve is a rectangular hyperbola.
•(c) It can not intersect X-axis or Y-axis.
Average
Fixed Cost
Average variable cost

• Average variable cost:

• It is per unit variable cost of production of a
commodity. AVC is U-shaped due to law of variable
proportion.
• AVC = TVC/Q
• AVC = AC -AFC
Marginal Cost

• Marginal Cost –
• It refers to change in TC, due to additional unit of a
commodity produced.
• MC = ΔTC/ΔQ or MCn = TCn – TCn–1.
• Under short run, it is calculated from TVC.
• MCn = TVCn – TCn-1
• MC = ΔTVC/ ΔQ
Relation Between Short-
Term Cost Curves

 Total cost curve and total variable cost

curve remains parallel to each other. The vertical
distance between these two curve is equal to total
fixed cost.
 TFC curve remains parallel to X-axis and TVC
curve remains parallel to TC curve.
• With increase in level of output, the vertical distance
between AFC curve and AC curve goes on
increasing. On contrary the vertical distance
between AC curve and AVC curve goes on decreasing
but these two curves never intersect because
average fixed cost is never zero
Relation between MC and
AVC. •Relation between MC
and AVC.
 When MC < AVC, AVC
falls.
 When MC = AVC, AVC
is minimum and
constant
 When MC > AVC, AVC
rises.  
 MC curve cuts AVC
curve at its lowest
point.
 Both curves are U-
shaped
Relation between MC
and AC •Relation between MC
and AC:- 
 When AC falls, MC
< AC.
 When AC rises, MC >
AC.
 When AC is constant
and minimum, MC =
 AC.
Revenue • Money received from the sale of product is called
revenue.
• Total revenue is the total amount of money
received by a firm from the sale of given units of
a commodity.
• TR = Quantity X Price
AVERAGE • Average Revenue :
REVENUE • Refers to revenue per unit of output sold.
• Average revenue is equal to price.
• AR is also called per unit price of a commodity.
• AR = TR/Q
Marginal • Marginal Revenue is net addition to total revenue
when one additional unit of output is sold
Revenue
• It is the additional revenue generated from the
sale of an additional unit of output
• MRn = TRn – TRn-1
• MR = Change in TR/Change in Q
 • Relation b/w AR and MR (General relationship)
Relation b/w • When MR = AR, AR is maximum and constant.
AR and MR • MR can be negative, but not AR.
• AR increases as long as MR is higher than AR(MR
> AR)
• When MR < AR, AR falls.
• When TR increases at an increasing rate, MR and
AR also increases.
Relation b/w • Relation b/w TR, AR, and MR when more
TR, AR, and quantity sold at the same price : under perfect
competition
MR(Price • a) Average revenue and marginal revenue remains
constant) constant at all levels of output and AR and MR
curves are parallel to ox-axis.AR= MR.
• (b) Total revenue increases at constant rate MR is
constant and TR curve is positively sloped
straight line passing through the origin.
 • Relation between TR, AR and MR when more
Relation quantity is sold at the lower price or there is
monopoly or monopolistic competition in the
between TR, market.
AR and • (a) Average revenue and marginal revenue curves
MR (price is have negative slope. MR curve lies below AR
curve. AR > MR
not constant) • (b) Marginal revenue falls, twice the rate of
average revenue.
• c) So long as marginal revenue decreases and
positive, total revenue increases at diminishing
rate. When marginal revenue is zero, total
revenue is maximum and when marginal revenue
becomes negative, TR starts falling.
NORMAL PROFIT

Normal Profit:- It is a no profit no loss situation

• It is achieved when P = AC.
• It is the minimum return that a producer expects from his capital invested in
the business.
 • Shut-down Point:- 
Shut-down • It refers to a situation when a firm is able to
point cover its variable costs only
• It occurs when a firm is covering its variable
costs only, here, the firm is  incurring loss of
fixed cost.
• TR received is just equal to TVC
Shut –down
price
Break-even
Point • It refers to the point where the TR =TC
• It occurs when AR = AC or (TR = TC).
• At this point, firm is earning zero economic
profit or normal profit. OR we can say it is just
covering all its costs.
Supply
1.Supply: Refers to the amount of the commodity
that a firm is willing and able to  sell at a given
price during a given period of time.
INDIVIDUAL SUPPLY AND MARKET
SUPPLY

• Individual supply refers to quantity of a commodity that an individual

firm is willing and able to offer for sale at a given price during a given
period of time.
• Market supply refers to quantity of a commodity that all firms are
willing and able to offer for sale at a given price during a given period of
time
Stock

• Stock refers to total quantity of a particular commodity that is available

with the firm at a particular point of time.
• Supply is that part of stock which a producer is willing to bring into the
market for sale
• Supply relates to a period of time whereas stock relates to a particular
point of time
1.Individual Supply: Refers to quantity of a commodity that
an individual firm is willing and able to offer for sale
at different price during a given period of time.
2.Market supply: It is the sum total of quantity supplied of a
commodity by all sellers or all firms in the market at
different price and in a given period of time.
Supply Function

• Shows the functional relationship between quantity supplied of a particular commodity and the
factors influencing it.
• It can be with respect to one producer or to all the producers in the market
• Sx = f (Px, Po, Pf, St, T, G)
• Sx= supply of the given commodity
• Px = Price of the given commodity
• Po = Price of other goods
• Pf =Price of factors of production
• St= State of technology
• G= Goals of firm
• T = Taxation policy
 • Price of the given commodity:
Factors • Price of a commodity and its supply are
directly related.
affecting • As price increases, the quantity supplied of the
supply of a given commodity also rises.
• Prices of other related goods:
commodity(Det • Increase in price of other goods make
erminants of production of those goods more profitable in
comparison to the given commodity.
supply)
• Price of factors of production:
• As the price of inputs increases, the cost of production increases and will lead to decrease in supply
• With the fall in the price of inputs, cost of production decreases and profit margin increases.
• It will lead to increase in supply
• Level of Technology:
• Advanced and improved technology reduces cost of production and raises the profit margin.
• It induces the seller to sell more.
• Technological degradation increases the cost of production and will lead to decrease in supply
• Government policy regarding Taxation and subsidies:
• Increase in taxation increases the cost of production and decreases the
supply
• Decrease in taxation decreases the cost of production and increases the
supply
• Subsidies reduce cost of production and increase the supply and vice versa
• Goals of the firm:
• If the goal of the firm is profit maximization, then supply increases with
increase in price
• If the goal of the firm is to capture extensive markets, then it may increase
the supply at a price that would not maximise profit
• No. of firms:
• Increase in the number of firms increases the market supply
• If firms leave industry then it reduces the market supply
• Future expectation of price:
• If sellers expect a rise in price in near future, then supply will decrease
• If sellers expect a fall in price in near future, then supply will increase
1.Supply curve: Refers to the graphical representation of supply schedule
which represents various quantities of a commodity that a producer is
willing to supply at different prices during given period of time.
2.Slope of supply curve = ΔP/ΔQ. A supply curve has a positive slope.
Supply Curve
Supply
Schedule • Supply Schedule: Refers to a tabular
presentation which shows various quantities of a
commodity that a producer is willing to supply at
different prices, during a given period of time.
Supply Schedule
Law of Supply

• Law of Supply:
•  Law of supply states that other factors remaining constant, price and
quantity supplied of a good are directly related to each other
• It states the direct relationship between price and supply of a
commodity, keeping other factors constant.
• Higher the price, higher the supply and lower the price, lower the
supply.
Assumptions
of Law of • Price of other goods remain constant
Supply • No change in the state of technology
• Prices of factors of production remain same
• No change in taxation policy
• Goals of the producer remain same
 • When quantity supplied of a commodity changes
due to change in its own price, keeping other
Movement factors constant, it is known as change in
along the quantity supplied.
• It is graphically expressed as a movement along
supply curve the supply curve
• Expansion in supply is shown by an upward
movement along the supply curve from ‘B’ to ‘C’.
• Expansion in supply is caused due to rise in
price of the commodity.
• It is also called increase in quantity supplied or
extension in supply
• Contraction is shown by downward movement
along the supply curve from ‘B’ to ‘A’
• Contraction in supply is caused due to fall in
price of the commodity
• It is also called decrease in quantity supplied
Movement along
the supply curve
 • When supply of a commodity changes due to
change in any factor other than the price of the
commodity, it is known as change in supply
Shift in • It is graphically expressed as shift(rightward and
supply curve leftward) in supply curve
• Increase in supply is shown by a rightward shift
in the supply curve.
• Supply rises due to favourable change in other
factors at the same price
• Decrease In supply is shown by a leftward shift in
the supply curve
• Supply falls due to unfavourable change in other
factors at the same price
Shift in
Supply curve
 • Supply curve shifts towards right due to :
• Decrease in price of other goods

Supply curve • Decrease in price of factors of production

• Advanced and improved technology
shifts • Favourable taxation policy(decrease in taxes)
towards • Goal of sales maximization
• Increase in the number of firms
right • Expectation of fall in prices in future
• Improvement in means of transport and
communication
 • Supply curve shifts towards left due to:
• Increase in price of other goods
Supply curve • Increase in price of factors of production
• Complex and outdated technology
shifts towards • Unfavourable taxation policy(increase in
left taxes)
• Goal of profit maximization
• Decrease in the number of firms
• Expectation of rise in prices in future
• Poor means of transport and communication
 Price • Price Elasticity of Supply: Refers to the
degree of responsiveness of supply of a

Elasticit commodity with reference to a change in

price of the commodity.
• It is always positive due to direct
y of relationship between price and quantity
supplied.

Supply • It points out the reaction of the sellers to

a particular change in the price of the
commodity
 Kinds of • Depending upon the degree of
responsiveness of the quantity
elasticities supplied to the price change,
there are five kinds of price
of supply elasticities of supply
Perfectly elastic
supply
• When there is an infinite supply at
a particular price and the supply
becomes zero with a slight fall in
price, then the supply of such a
commodity is said to be perfectly
elastic
• Es = ∞
Perfectly inelastic
supply
• When the supply does not change with
change in price, then supply for such a
commodity is said to be perfectly inelastic
• Es = 0
Highly elastic
supply
• When percentage change in
quantity supplied is more than the
percentage change in price, then
supply for such a commodity is
said to be highly elastic
• Es > 1
Less elastic supply

• When percentage change in

quantity supplied is less than the
percentage change in price, then
supply for such a commodity is
said to be less elastic
• Es < 1
Unitary elastic
supply
• When percentage change in
quantity supplied is equal to
percentage change in price, then
supply for such a commodity is
said to be unitary elastic
• Es =1
 • Percentage change method:
Calculation • Elasticity is measured as the ratio of percentage
of price change in the quantity supplied to percentage
change in price
elasticity of • Es = % change in quantity supplied/% change in price
Supply • Percentage change in price = change in price/initial
price X 100
• Percentage change in quantity supplied = change in
quantity supplied/initial quantity supplied X 100
• Change in price =New price(P1)-initial price(P)
• Change in quantity = New quantity(Q1)- initial
quantity(Q)
 • 1. At the price of Rs 10 per unit, a firm supplies 50 units of
a commodity. When price rises to Rs 12 per unit, the firm
increases the supply to 70 units. Find elasticity of supply.
• P= 10, P1 = 12, Q = 50, Q1 = 70, Es =?
Examples • Es = % change in quantity supplied/% change in price
• % change in quantity supplied = change in quantity
supplied/initial quantity supplied X 100
• = 20/50 X 100 = 40%
• Percentage change in price = change in price/initial price X
100
• = 2/10 X 100 =20%
• Es = 40%/20% =2
• Es is highly elastic since Es>1
QUESTIONS

• 2. The supply for a good is 50 units at the price of Rs 10. When price
rises by Rs 5, supply also rises by 50 units. Calculate Es.
• P =10, P1= 15, Q = 50, Q1 = 100, Es =?
• 3. The price of a good is Rs 12 per unit and quantity supplied is 500
units. When the price rises to Rs 15 per unit, its quantity supplied rises
to 650 units. Calculate Es.
QUESTIONS

• 4. When the price of a commodity falls by 20%, the quantity supplied

decreases by 25%. Find out its price elasticity of supply.
• 5. When the price of a commodity falls from Rs 8 per unit to Rs 6 per
unit, its supply falls by 25 units from 125 units. Calculate Es.
• 6.The price of a commodity is Rs 10 per unit and its quantity supplied at
this price is 500 units. If its price falls by 10 % and quantity supplied falls
to 400 units, calculate Es.
• 7. Quantity supplied of a commodity increases by 25% when its price
rises from Rs 4 per unit to Rs 5 per unit. Calculate Es.