Unit-III

Production and Cost

Q1). What is the production function?

Sol: The functional relationship between the physical input (or factor of production) and therefore the output is named a production function. It assumed the input as an explanatory or independent variable and the output as a dependent variable. Mathematically, you can write this as:

Q=f(L,K)

Where"Q"represents the output,"L"and"K" are the inputs, respectively, labour and capital (such as machinery). Note that there may be many other factors, but we are assuming a two-factor input here. Production functions are defined differently in the short term and in the long term. This distinction is crucial in microeconomics. This distinction is based on the nature of the factor input.

Inputs that change directly with the output are called variable factors. These are factors that can change. Fluctuating factors exist both in the short term and in the long term. Examples of variable factors include daily labour and raw materials.

On the other hand, factors that cannot change or change as the output changes are called fixed factors. These factors are usually characteristic only for a short or short period of time. There are no fixed factors in the long term.

Therefore, two production functions can be defined: short-term and long-term. A short-term production function defines the connection between one variable factor (keeping all other factors fixed) and therefore the output. The law of regression to factors explains such a production function.

For example, suppose that a company has 20 units of Labour and 6 acres of land, and initially uses only Labour units (variable coefficients) for that land (fixed coefficients). Thus, the ratio of land and labour is 6: 1. Now, if the company chooses to adopt 2 labour units, then the ratio of land to Labour will be 3: 1 (6: 2).

Here, all factors change in the same proportion. The law used to explain this is called the law of return to scale. It measures how much of the output changes when the input changes proportionally.

Q2). How can you say that Firm acts as an agent of production?

Sol: Production requires the cooperation of certain factors. These are known as production agents. They are also called economic resources or inputs. Roughly, there are four agents: land, labour, capital and organization.

Production factors:

The production of goods or services requires the use of certain resources or production factors. They are called economic resources, because most of the resources needed to continue production are scarce compared to their demand. Resources, which we call production factors, are combined by companies and companies in various ways, creating an annual flow of goods and services .

In fact, any community resource, called a factor of production, can be classified in different ways, but it facilitates the generally acceptable classification, keeping in mind that the production of goods and services is the result of people working in natural resources and equipment such as tools, machinery and buildings. There is a time separated from the rest of the company, which is the fourth factor that distinguishes the company from the rest.

People involved in production use their skills and efforts to create things and do what is desired. This human effort is known as Labour. In other words, labour represents all human resources. The natural resources that people use are called land. And the equipment they use is called capital, and this refers to all artificial resource. The first three factors—land; labour and capital do not work independently or in isolation. It is necessary to combine these factors and adjust their activities. These two functions are performed by the organizer or entrepreneur.

Q3). Explain Law of variable proportions.

Sol: This law indicates a short-term production function in which one factor changes and the other is fixed. Also, if you get an extra output when applying an extra unit of input, this output will be equal to or less than the output obtained from the previous unit.

The law of variable proportions relates to how the output changes when the number of units of variable factors is increased. Thus, it refers to the effect of the changing factor ratio on the output. In other words, this law shows the relationship between the unit of variable factors and the volume of production in the short term. This assumes that all other factors are constant. This relationship is also known as the return to variable factors.

The law states that if we keep other factors constant, then when we increase the variable factor, the total product first increases at the rate of increase, then at the rate of decrease, and finally begins to decrease.

Q4).Explain the three stages of Law of Variable Proportion.

Sol: Stage I–TPP will increase at an increasing rate, and MPP will increase too. The MPP increases with the increase of the variable factor unit. Therefore, it's also called the stage of accelerating returns. In this example, Phase I of the law runs up to three units of labour (between points O and L).

Stage II–TPP continues to increase, but is declining. But the increase is a plus. In addition, the MPP decreases with an increase in the number of units of the variable factor. Therefore, it is called the stage of Return of decline. In this example, Stage II is performed between four to six units of labour (between points L and M). This stage reaches the point where TPP is maximum (18 in the example above) and MPP is zero (point R).

Stage III-   now the TPP begins to decrease, the MPP decreases and goes to the negative. Therefore, it's called the stage of negative returns. In this example, Stage III is performed between seven and eight units of labour (from Point M onwards).

Q5). What are the types of Economies of scale?

Sol: Economies of scale are divided into internal and external economies, which are discussed as follows:

i.Internal economy:

See the real economy arising from the expansion of the plant size of the organization. These economies arise from the expansion of the organization itself.

An example of an economy of internal size is:

a.Technical economy of scale:

It occurs when an organization invests in expensive and advanced technologies. This helps to reduce and control the production costs of the organization. These economies are enjoyed due to the technical efficiency obtained by the organization. Advanced technology allows organizations to produce a large number of goods in a short time. Thus, the industry-wide economy falls per unit of production costs

b.Marketing economy of scale:

Scale marketing economy is achieved in case of bulk purchase, branding, and advertising when large organizations have broadened their marketing budgets over large output. For example, large organizations enjoy the benefits of advertising costs as they cover a larger audience. On the other hand, small organizations pay the same advertising costs as big ones, but do not enjoy such benefits in advertising costs.

c.Financial economy of scale:

This happens when large organizations borrow money at a lower rate of interest. These organizations have good credibility in the market. In general, banks prefer to grant loans to organizations that have a strong foothold in the market and have good repayment capacity.

d.Management economy of scale:

During the occurrence of large organizations specialized workers for different things. These workers are experts in their respective fields and use their knowledge and experience to maximize the benefits of the organization. For example, in an organization, accounts and research departments are created and managed by experienced individuals so that all costs and benefits of the organization can be properly estimated.

E.Commercial economy:

See an economy where organizations enjoy the benefits of purchasing raw materials and selling finished products at a lower cost. Large organizations buy raw materials in bulk; therefore, enjoy the advantages of transportation charge from Bank, easy credit, and prompt delivery of products to customers.

Ii.Foreign economy:

Occurs outside the organization. These economies arise within industries that benefit organizations. If the industry expands, the organization will benefit from better transport networks,infrastructure and other facilities. This will help reduce the cost of the organization.

Some examples of economies of external scale are discussed as follows:

A.Economy of concentration:

See the economy resulting from skilled labor, better credit, and the availability of transport facilities.

B.Economy of information:

Means the benefits gained from trade and business related publications. The central research institution is the source of information for the organization.

C.Collapsing economy:

Refer to the division of associations caused by the economic process into different processes. Uneconomics of scale occurs when the long-term average cost of an organization increases. It can occur when the tissue becomes excessively large. In other words, uneconomics of Scale Causes larger organizations to produce goods and services at increased costs.

Q6). Explain the several causes of diseconomics of scale.

Sol: Some of the causes that lead to uneconomics of scale are:

i. Act as the main reason for diseconomics of scale. If the organization's production goals and objectives are not properly communicated to employees in the organization, they can lead to overproduction or production. This can lead to diseconomics of scale.

Separately, if the communication process in the organization is not strong, then the employee will not get enough feedback. As a result, there will be less face-to-face interaction between employees, which will affect the production process.

Ii.Lack of motivation:

This leads to a decrease in productivity levels. For large organizations, workers may feel isolated and less motivated because they are less valued for their work. Because of poor communication networks, it is difficult for employers to interact with employees and build a sense of attributes. This leads to a decrease in the productivity level of output due to lack of motivation. This further leads to an increase in the cost of the organization.

Iii.Loss of control:

It serves as the main problem of large organizations. Monitoring and controlling the work of all employees in a large organization becomes impossible and expensive. It is difficult to make sure that all employees of the organization are working towards the same goal. It becomes difficult for managers to direct the sub-coordinates of large organizations.

Iv.Cannibalism:

It means a situation where an organization is facing competition from its products. While smaller organizations face competition from the products of other organizations, larger organizations find their products compete with each other.

Q7). Explain Cost behavior in the short term.

Sol: Short-term costs are important for understanding costs in economics. Short-term and long-term distinctions based on fixed and variable factors of production make the concept of understanding short-term costs easier. Let us understand the concept using examples, diagrams for graphical representation.

Short run concept

To understand short-term costs, it is important to understand the concept of short-term costs. In economics, we distinguish between short-term and long-term through the application of fixed or variable inputs.

Fixed input (plant, machine, etc.)) is a factor of production that can not be changed or changed in a short span because the period is"too small". This will be short-term. Here, the inputs are two types: fixed and variable.

In the long run, all inputs will be mutable(e.g.. Raw materials). This means that all inputs can be changed as the output volume changes. Therefore, the concept of fixed input applies only in the short term. It is in the short-term cost that we turn this time.

It explains that the cost of production depends on the level of output, given that others remain the same (ceteris paribus). This can be mathematically written as:

C=f(X)

Where C is the production cost and X is the output level.

Q8). Define Total fixed costs.

Sol: Fixed cost refers to the cost of fixed input. At the level of output it does not change (hence, fixed). Fixed inputs include buildings,machines, etc. Thus, the cost of inputs, such as rent and the cost of machines, constitute a fixed cost. Also known as overhead, supplemental or overhead, these costs remain the same regardless of the level of output.

So if you plot the total fixed cost (TFC) curve against the output level on the horizontal axis, you get a straight line parallel to the horizontal axis. This indicates that these costs remain the same and should occur even if the output level is zero.

Q9). Draw a diagram to show Total cost.

Sol: Total cost(TC) refers to the sum of fixed and variable costs incurred in the short term. So, the short-term cost can be expressed as follows

TC=TFC+TVC

Note that in the long run, TFC=0, so TC = TVC. So you can get the shape of the TC curve by summing the TFC curve and the TVC curve.

For the TC curve, the following points can be noted:

• The TC curve is shaped of reverse S. This is because of the TVC curve. Since the TFC curve is horizontal, the difference between the TC curve and the TVC curve is the same at each level of the output and is equal to the tfc. This is explained as follows: TC-TVC=TFC
• The TFC curve is parallel to the horizontal axis, and the TVC curve is inverted S-shaped.
• The law that explains the Shape of TVC and subsequent TC is called the law of variable proportions.

Q10). What are the main objectives of the company?

Sol: The main objectives of the company are:

• Achieve the target rate of return
• Stabilize price and profit margins
• Achieving target market share
• Prevent price competition
• Maximize sales or sales revenue

For a really while people believed that the only purpose of the corporate is to maximise profits. After all, every business wants to earn the maximum profit,right? But over the years beliefs have changed. Now it is believed that the only purpose is the maximization of profits only in the case of a single owner company.