ECONS

UNIT 3
Production

An activity that uses inputs of labour and capital to yield

output of goods or services
Example
Item Maximum Present Output Desired Output
Capacity

Samosas 1000 500 700

Cars 1000 500 700

Item Maximum Present Output Desired Output
Capacity

Samosas 1000 700 1500

Cars 1000 700 1500

Time Horizon
Market Period

Short Run

Long Run

Secular Period
 Production function
Exhibits a functional relationship between physical inputs and
physical output.

Q = f (x 1, . . . . , x N)
Short run analysis
Inputs are fixed and variable

Q=f(L, K)

The firm is subject to returns to a factor

Returns to a factor are subject to the Law of Variable

Proportions
Variants of output
Total Product

Average Product

Marginal Product
Workers Total Product/Output
0 0
1 2
2 5
3 9
4 12
5 14
6 15
7 15
8 14
 Law of variable proportions

Increasing the use of one input with all other inputs kept
constant, the marginal product of the variable input
initially increases, then decreases and ultimately becomes
negative.
Reasons
Initially –
◦ Optimal utilization of resources
◦ Specialization
Later –
◦ Indivisibility of the fixed factor
◦ Imperfect substitutability between factors
◦ Overcrowding
Phases in the operation of the Law
Increasing returns to a factor
Decreasing returns to a factor
Negative returns to a factor

Where should a producer operate?

Examples
1. Given: Q = 7L + 0.6L2 - 0.1L3
a. Find the average production function
b. Find the marginal production function

2. Given Q = - L3/3 + 2L2 + 12L

When will diminishing returns set in?
Long Run Analysis
Inputs are variable

Q=f(L, K)

The firm is subject to returns to scale

Returns to scale
Increasing returns

Constant returns

Diminishing returns
Reasons

Economies of Scale

Diseconomies of Scale
Revisit
The decision about resource usage
Production - meaning
Production function
Time horizons
Short run - inputs; law of variable proportion
Long run - inputs; law of returns to scale
The decision about the right level of variable input employment in short
run/ level of operation
The decision about the right scale of production in the long run/ plant size
Revenue
TOTAL REVENUE, AVERAGE REVENUE, MARGINAL
REVENUE
Calculate and draw TR, AR, MR
P Q
10 1
9 2
8 3
7 4
6 5
5 6
4 7
Question
Three crystal vases can be sold for Rs. 12000 each.
If the fourth vase is sold, it would fetch Rs. 10500, at what
price can all the four vases be sold?
Cost of Production
Determinants of Cost
Price of factor inputs

Technology

Level of output
Cost Classification

 Short run Costs

 Long Run Costs

Short Run Costs

Fixed Costs (Supplementary)

Variable costs (Prime)

Q TC TFC TVC AC AFC AVC MC
0 500
1 550
2 580
3 605
4 629
5 650
6 680
7 725
8 780
9 860
Graphical presentation
Long Run Costs

In LR all inputs are variable, therefore all costs are

variable

No fixed cost
 Graphical presentation

LAC AND LMC ARE MORE FLAT THAN THEIR

SHORT RUN COUNTERPARTS
NH Case
Examples
Given, C = 45Q2
Find AC for Q = 2
Find MC for Q = 3

Given, TC = 100Q - 10Q2 + 5Q3

Find Q where AC is equal to MC
Find the optimum level of output
Revisit
Revenue – Meaning, variants
Cost of production – meaning, determinants
Short run costs – meaning, composition, graphical
presentation, underlying reason(s)
Long run costs – meaning, components, graphical
presentation, underlying reason(s)