Production, Cost and Revenue

Production, Cost and Revenue
Production Function
Q=f(L,N,K,E……..n)
Q=f(F1,F2,F3,F4………n)
Fixed and Variable Factors

Cobb Douglas Production Function
Q=A.Lα.Kβ
Q=Total Output for 365 days
A= Change in Output
L= Labour Hours
K= Machine hours
α= Output elasticity of L to Q
β= Output elasticity of K to Q
Cost Function
C=f(r,w,i,p……..n)
C=f(C1,C2,C3,C4………n)
Fixed and Variable Cost

Short-run costs
Fixed Cost
Variable Cost
And
Total cost
Output FC
100 (Q) (Rs)
0 12
80
1 12
2 12
60 3 12
4 12
5 12
40 6 12
7 12
20
0
0 1 2 3 4 5 6 7 8
Output FC
100 (Q) (Rs)
0 12
80
1 12
2 12
60 3 12
4 12
5 12
40 6 12
7 12
20
0
0 1 2 3 4 5 6 7 8
FC
Output FC VC
100 (Q) (Rs) (Rs)
0 12 0
80
1 12 10
2 12 16
60 3 12 21
4 12 28
5 12 40
40 6 12 60
7 12 91
20
0
0 1 2 3 4 5 6 7 8
FC
Output FC VC
100 (Q) (Rs) (Rs)
0 12 0 VC
80
1 12 10
2 12 16
60 3 12 21
4 12 28
5 12 40
40 6 12 60
7 12 91
20
0
0 1 2 3 4 5 6 7 8
FC
100
80
VC
60 Diminishing marginal
returns set in here
40
20
0
0 1 2 3 4 5 6 7 8
FC
Output FC VC TC
100 (Q) (Rs) (Rs) (Rs)
0 12 0 12 VC
80
1 12 10 22
2 12 16 28
60 3 12 21 33
4 12 28 40
5 12 40 52
40 6 12 60 72
7 12 91 103
20
0
0 1 2 3 4 5 6 7 8
FC
Fixed and variable costs
Y Output FC VC TC
100 (Q) (Rs) (Rs) (Rs) TC
0 12 0 12 VC
80
1 12 10 22
2 12 16 28
60 3 12 21 33
4 12 28 40
5 12 40 52
40 6 12 60 72
costs
7 12 91 103
20
0
0 1 2 3 4 5 6 7 8
FC
X
output
Fixed and variable costs
Y Output FC VC TC
100 (Q) (Rs) (Rs) (Rs) TC
0 12 0 12 VC
80
1 12 10 22
2 12 16 28
60 3 12 21 33
4 12 28 40
5 12 40 52
40 6 12 60 72
costs
7 12 91 103
20
0
0 1 2 3 4 5 6 7 8
FC
X
output
Total physical product
(TPP)
THE LAW OF VARIABLE PROPORTIONS
OR
The law of diminishing (marginal) returns
A more units of the variable factor are used,

there will come a point where additional units
of the variable factor will produce less than
previous units.
Wheat production per year from a particular farm
d
L TPP
40
0 0 TPP
Tonnes of wheat produced per year
1 3
30 2 10 Maximum output
3 24
4 36 Point of inflexion
20 5 40
b
6 42
7 42
10 8 40
0
0 1 2 3 4 5 6 7 8
Number of farm workers
Short-run production
Marginal physical
product (MPP)
= TPP/Qf
14
L MPP
12 0 0
Tonnes of wheat per year
10 1 3
2 7
8
3 14
6 4 12
5 4
4
6 2
2 7 0
0
8 -2
0 1 2 3 4 5 6 7 8
-2
Number of
MPP
farm workers (L)
Short-run costs
Marginal cost
= TC / Q
Costs (£) Deriving marginal costs
35
Q TC MC MC
30
0 12
25
1 22 10
2 28 6
20 3 33 5
Diminishing marginal
4 40 7
15 returns set in here
5 52 12
10 6 72 20
7 103 31
5
0
0 1 2 3 4 5 6 7
Q
Short-run production
Average physical
product (APP)
= TPP/Qf
L
14
APP
0 0
12
10
1 3
6
2 5
4
3 8
2
4 9
0
0 1 2 3 4 5 6 7 8
5 8
APP
-2
Number of farm workers (L) 6 7

7 6
8 5
Short-run costs
Average cost
=TC / Q
Costs (£) Q TC AC
35
0 12
30 1 22 22
2 28 14
25 3 33 11
20
4 40 10
5 52 10.4
15 6 72 12
7 103 14.7
10 AC
0
0 1 2 3 4 5 6 7
Q
14
12
10
6
APP
4
0
0 1 2 3 4 5 6 7 8
-2 Number of MPP
farm workers (L)
Relationship Between
SAC
35 And SMC
MC
30
25
20
15
10 AC
0
0 1 2 3 4 5 6 7
Q
d
40

TPP
30
20
b
10
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14
b
12
10
4 APP
2
0 d Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
MPP
LAW OF VARIABLE PROPORTIONS
Number of
workers TPP MPP APP
0 0 0 0
1 3 3 3
2 10 7 5
3 24 14 8
4 36 12 9
5 40 4 8
6 42 2 7
7 42 0 6
8 40 -2 5
LAW OF VARIABLE PROPORTIONS (short run
production function) d
40
c

TPP
30
20
Maximum
b output
Diminishing returns
set in here
10
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14
b
I II III
12
10
c
8
4 APP
2
0 d Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
MPP
40 TP AP MP c

TPP
30
TP AP MP
20
TP AP MP
10
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14
I II III
12
10
c
8
4 APP
2
0 d Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
MPP
40 TP AP MP c

TPP
30
TP AP MP
20
Inflexion
TP AP MP
10
0 Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
14
I II III
12
10
c
8
4 APP
2
0 d Number of
0 1 2 3 4 5 6 7 8 farm workers (L)
-2
MPP
Relationship Between AC And MC
Y
AC
AC < MC
MC
costs
X
o
output
Q
AC = MC
AC=MC
Q
MC
AC < MC
AC
Q
35
Q FC AFC
30
0 12 -
1
25 12 12
2 12 06
20
3 12 04
4
15
12 03
5 12 2.4
6
10 12 02
7 12 1.7
5
0
0 1 2 3 4 5 6 7
AFC
Q
AFC & AVC
35 Q FC AFC VC AVC
0 12 - 0 -
30
1 12 12 10 10
25 2 12 06 16 8
3 12 04 21 7
AFC & AVC
20 4 12 03 28 7
5 12 2.4 40 8
15
6 12 02 60 3 10
10 7 12 1.7 91 13
5
AVC
0
0 1 2 3 4 5 6 7
AFC
OUTPUT Q
Costs (£) Q TC AC
35
0 12
30 1 22 22
2 28 14
25
3 33 11
20
4 40 10
5 52 10.4
15 6 72 12
7 103 14.7
10 AC
5
AVC
0
0 1 2 3 4 5 6 7
AFC
Q
All Short run costs
MC
AC
AVC
Costs (RS)
AFC
Output (Q)
Isoquant Analysis
An isoquant
45
40 Units Units Point on

of K of L diagram
35 40 5 a
20 12 b
30
Units of capital (K)
10 20 c
6 30 d
25
4 50 e
20
15
10
0
0 5 10 15 20 25 30 35 40 45 50
Units of labour (L)
An isoquant
45
40 a
Units Units Point on
of K of L diagram
35 40 5 a
20 12 b
30
10 20 c
6 30 d
25
4 50 e
20
15
10
0
0 5 10 15 20 25 30 35 40 45 50
Units of labour (L)
An isoquant
45
40 a
of K of L diagram
35 40 5 a
20 12 b
30
10 20 c
6 30 d
25
4 50 e
b
20
15
10
0
0 5 10 15 20 25 30 35 40 45 50
Units of labour (L)
An isoquant
45
40 a
of K of L diagram
35
12 1 a
8 2 b
30
5 3 c
25 3 4 d
2 5 e
20 b
15
10 c
d
5 e
0
5 10 15 20 25 30 35 40 45 50
Units of labour (L)
Isoquant analysis
Diminishing marginal
rate of factor
substitution
Diminishing marginal rate of factor substitution
14
12
g
MRS = 2 MRFS = K / L
K = 2
10 h
L = 1
8
2
isoquant
0
0 2 4 6 8 10 12 14 16 18 20
Units of labour (L)
Diminishing marginal rate of factor substitution
14
12
g
MRS = 2 MRS = K / L
K = 2
10 h
L = 1
8
j MRS = 1
K = 1 k
6
L = 1
4
2
isoquant
0
0 2 4 6 8 10 12 14 16 18 20
Units of labour (L)
Isoquant analysis
An isoquant map
An isoquant map
30
20
10
IQ500
IQ400
IQ300
IQ200
IQ1OO
0
0 10 20
Units of labour (L)
Isoquant analysis
Isocosts
An isocost
30
Assumptions
25
PK = £20 000
20 W = £10 000
TC = £300 000
15
10
0
0 5 10 15 20 25 30 35 40
Units of labour (L)
An isocost
30
25
Assumptions
FACTOR Y Units of capital (K)
PK = rs20 000
20 W = rs10 000
TC = rs300 000
Aa
15
b
10
E
c
5
TC = rs300 000
0
d
0 5 10 15 20 F 25 30B 35 40
FACTOR X Units of labour (L)
Isoquant analysis
The least-cost
method of production
Finding the least-cost method of production
35
Assumptions
30
PK = £20 000
W = £10 000
25
TC = £200
20 000
TC = £300 000
15
TC = £400 000
10 TC = £500 000
0
0 10 20 30 40 50
Units of labour (L)
least-cost Factor Combination method of production
35
30
A25
s
TC = Rs 500 000
20
C
15
TC = Rs 400 000
r
10
t
5 IQ=100
0
0 10 20 30 40 D 50 B
Units of labour (L)
LONG RUN PRODUCTION FUNCTION
Returns to scale
Increasing returns to scale
4
E DE
3
Units of factor
b Q
2
a
1
0
0 1 2 3
Units of output
Constant returns to scale
4
E DE
Q
3
Units of factor
b
f22
f1 a
1
0
0 q1
1 2
q2 3
Units of output
Decreasing returns to scale
4
E DE Q
3
Units of factor
b
f22
a
f1 1
0
0
q1 q2
1 2 3
Units of output
Increasing Returns to scale
4
Q
3
d
c
2
b
500
a 400
1
300
200
0
0 1 2 3
Units of labour (L)
Constant returns to scale
4
Q
c
3 600
b 500
2
400
a
1
300
200
0
0 1 2 3
Units of labour (L)
Decreasing returns to scale
4
Q
c
3 500
b
2
400
a
1
300
200
0
0 1 2 3
Units of labour (L)
Returns to scale
4
3
DRS
CRS
1
IRS
0
0 1 2 3
Units of labour (L)
Returns to scale
Q=A.Lα.Kβ
IRS = α + β > 1
CRS = α + β = 1
DRS = α + β < 1
Long-run costs
Long-run costs and

Economies-Diseconomies of
Scale
Economies of Scale
The advantages of large scale production that

result in lower unit (average) costs (cost per
unit)
AC = TC / Q
Economies of scale – spreads total costs over a
greater range of output
Economies of Scale-Internal
Internal – advantages that arise as a result of

the growth of the firm
Production
Managerial
Labour
Capital
Economies of Scale-External
External economies of scale – the advantages firms

can gain as a result of the growth of the industry –
normally associated with a particular area
Supply of skilled labour
Global
Technological
Market
Economies of Scale
Increased Dimensions: e.g.
Transport container = Volume of 20m3
Total Cost: Construction, driver, fuel,
2m maintenance, insurance, road tax =
2m £600 per journey
5m AC = £30m3
Total Cost = £1800 per

journey
AC = £11.25m3
4m
4m
10m
Transport Container 2 = Volume 160m3
long-run average cost curves
Economies of Scale
Costs
LRAC
O Output
Alternative long-run average cost curves
Constant costs
Costs
LRAC
O Output
Alternative long-run average cost curves
LRAC
Diseconomies of Scale
Costs
O Output
A typical long-run average cost curve
Economies Constant Diseconomies LRAC

of scale costs of scale
Costs
O Output
A typical long-run average cost curve
LRAC
Costs
O Output
Long-run average and marginal costs
Economies of Scale
Costs
LRMC
O Output
LRMC
Diseconomies of Scale
Costs
O Output
Constant costs
Costs
LRMC
O Output
Long-run costs
Relationship between
long-run AC and MC
curves
LRMC
Initial economies of scale,
then diseconomies of scale
LRAC
Costs
O Output
long-run average cost curves
ENVELOPE CURVE
SRAC5
SRAC1 SRAC4
SRAC2 SRAC3
LAC
Costs
O
Output
DERIVATION OF LONGRUN MARGINAL COST CURVE
MC1
MC5
LMC
MC2
MC4
MC3 SRAC5
SRAC1 SRAC4
SRAC2
SRAC3 LAC
Costs
O Output
Revenue
Markets on the basis of Competition
Perfect Competition Imperfect Competition
PRICE TAKERS PRICE MAKERS

(and on the basis of number of sellers)
ONE TWO FEW MANY

LARGE
Monopoly Duopoly Oligopoly Monopolistic Perfect
Competition
Comp.
Imperfect Competition
(number of sellers increase from left to right)

(and on the basis of number of sellers)
Perfect Competition Imperfect Competition

eg. Agricultural • Monopoly
produce in India eg. Indian Passenger
Railways
• Duopoly
eg. Boeing vs Airbus
• Oligopoly
eg. Telecom in India
• Monopolistic
Competition
eg. Banking, FMCG,
Automobiles
Perfect Competition
Price-taking firm
(a) Average and
marginal revenue
revenue for a price-taking firm
(perfect competition)
Quantity Price = AR TR
AR MR
(units) = MR (rs) (rs)
0 5 0 0 0
200 5 1000 5 5
400 5 2000 5 5
600 5 3000 5 5
800 5 4000 5 5
1000 5 5000 5 5
1200 5 6000 5 5
Deriving a firm’s AR and MR: price-taking firm
Price (£)
AR, MR (£)
S
Pe
D
O O
Q (millions) Q (hundreds)
(a) The market (b) The firm

Deriving a firm’s AR and MR: price-taking firm
HORIZONTAL AR MR CURVES
Price (£)
AR, MR (£)
S
P D = AR
P
= MR
D
O O
Q (millions) Q (hundreds)
(a) The market (b) The firm

Revenue
Price-taking firm
(b) Total revenue
Total revenue for a price-taking firm
6000 Quantity Price = AR TR
(units) = MR (£) (£)
5000
0 5 0
200 5 1000
4000 400 5 2000
600 5 3000
800 5 4000
TR (£)
3000
1000 5 5000
1200 5 6000
2000
1000
0
0 200 400 600 800 1000 1200
Quantity
6000 Quantity Price = AR TR
(units) = MR (£) (£)
5000
0 5 0
200 5 1000
4000 400 5 2000
600 5 3000
800 5 4000
TR (£)
3000
1000 5 5000
1200 5 6000
2000
1000
0
0 200 400 600 800 1000 1200
Quantity
6000 Quantity Price = AR TR TR
(units) = MR (£) (£)
5000
0 5 0
200 5 1000
4000 400 5 2000
600 5 3000
800 5 4000
TR (£)
3000
1000 5 5000
1200 5 6000
2000
1000
0
0 200 400 600 800 1000 1200
Quantity
6000 TR
5000
4000
TR (£)
3000
2000
1000
0
0 200 400 600 800 1000 1200
Quantity
Break Even Chart
TR
sts/Revenue TC
Y Profit
Loss
FC
X
Q
Output/Sale
Break even calculation
i. Volume / Quantity / Output / Units

BEP = TFC/P – AVC
ii. Sales / value / rupees /

BEP = TFC/Contribution Ratio
Whereas,
Contribution Ratio = TR – TVC/ TR
Revenue
Firm facing a
downward-sloping
demand curve
AR and MR curves for a firm facing a downward-sloping D curve
8 Q P
(units) =AR
1 (£)
8
6
2 7
3 6
4 4 5
5 4
AR, MR (£)
6 3
2 7 2
0 AR
1 2 3 4 5 6 7
-2
Quantity
-4
8 Q P TR MR
(units) =AR (£) (£)
1 (£)
8 8
6
7 6
2 14
6 4
3 18
5 2
4 4 20
4 0
5 20
-2
AR, MR (£)
6 3 18
2 -4
2 7 14
0 AR
1 2 3 4 5 6 7
-2
Quantity
-4
8 Q P TR MR
(units) =AR () ()
1 ()8 8 8
6 2 7 14 6
3 6 18 4
4 5 20 2
4
5 4 20 0
18 -2
AR, MR (£)
6 3
2 7 2 14 -4
0 AR
1 2 3 4 5 6 7
-2
Quantity
-4
MR
Revenue
Firm facing a downward-

sloping demand curve
(b) Average and
marginal revenue
TR curve for a firm facing a downward-sloping D curve
20
16
12
Quantity P = AR TR
8 (units) (£) (£)
TR (£)
1 8 8
4 2 7 14
3 6 18
4 5 20
0 5 4 20
0 1 2 3 4
65 6
3 7
18
7 2 14
Quantity
20
16
12
Quantity P = AR TR TR
8 (units) (£) (£)
TR (£)
1 8 8
4 2 7 14
3 6 18
4 5 20
0 5 4 20
0 1 2 3 4
65 6
3 7
18
7 2 14
Quantity
Revenue
Revenue and
price elasticity of
demand
8
Elastic
6
Elasticity = -1
4
AR, MR (£)
Inelastic
2
0 AR
1 2 3 4 5 6 7
-2
Quantity
-4
MR
Elasticity = -1
20
In
tic
el
16
as
as
El
tic
12
TR
8
TR (£)
0
0 1 2 3 4 5 6 7
Quantity
Break Even Analysis
TC
sts/Revenue
Y
BEP
Profit Loss
E
TR
Loss
FC
X
Q
Output/Sale

Production, Cost and Revenue

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Production, Cost and Revenue

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Production, Cost and Revenue

Fixed and Variable Factors

Fixed and Variable Cost

A more units of the variable factor are used,

Number of farm workers (L) 6 7

Tonnes of wheat per year

Tonnes of wheat per year

Tonnes of wheat per year

Tonnes of wheat per year

40 Units Units Point on

Long-run costs and

The advantages of large scale production that

Internal – advantages that arise as a result of

External economies of scale – the advantages firms

Total Cost = £1800 per

Economies Constant Diseconomies LRAC

Perfect Competition Imperfect Competition

PRICE TAKERS PRICE MAKERS

ONE TWO FEW MANY

(number of sellers increase from left to right)

Perfect Competition Imperfect Competition

(a) The market (b) The firm

(a) The market (b) The firm

i. Volume / Quantity / Output / Units

ii. Sales / value / rupees /

Firm facing a downward-

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