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M_E_Final_5_PRO_Fun__CB_CC

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# PRODUCTION FUNCTION

PRODUCTION FUNCTION
Production is a transformation of physical inputs into physical output. The out put is thus a function of inputs. The production function is a technological relationship between the inputs, called the factors of production and the outputs.

Economy’s factors of the production are the quality of land (LD), Labour (L), capital (K), and entrepreneurship (E), that the economy possesses and uses in the production. Besides these, technology (T) effects the production. Since Land – Natural resource is fixed, it ceases to be factor in explaining the changes in output. Thus the economy’s production function may expressed as follows:

Y= f ( L, K. T) or Y = f [x1, x2,x3,……….Xn; T]
Y=Real GDP/ Quantity of production Where f= functional Relationship x1, x2,x3,……….Xn indicates the quantity used as factors. T = at given Technology.

No prudent economy employ an extra unit input, unless its increase.

would of any output

Here also Low of diminishing retune will apply, not only to the production of goods but also to the goods and services.

Production Function

Q= f (L

, L, K, M, T)

Q= output in physical units of good x

∞employed in the production of Ld = Land units

Q L = Labour units employed in the production of Q K = Capital units employed in the production of Q M= Managerial units employed in the production of Q T = Technology employed in the production of Q f = Unspecified function Fi = Peripheral derivatives of Q with respect to ith function.

It should be noted that above function gives the maximum possible output that can be produced from given amount of various outputs OR alternatively the minimum quantity of inputs necessary to produce given level of output. This is a general production function. A special production function may not have all these input or may have some inputs in disaggregated terms. Production function can be expressed and analyzed through TABLE, GRAPH & EQUATION.

This means the Marginal Physical Production (MPP) of Each factor declines as more and more of that is used in production, the other factors remains constant.
Figure shows the output as a function of the labour, Keeping other factor constant. Such can be drown for other factors Also Up to point A slop Convex then Between A-B concave and Out after B downward put sloping curve . (Y) This is because MPP of variable first rises, then falls, hits zero, and turns negative thereafter o Labour

B A

Assumptions:
1. P F like demand function must be considered with reference to a particular period of time 2. P F of a firm is determined by6 the state of technology. 3. Firm uses the best and efficient methods. 4. Factors are divisible into viable units.
Production Function can be represented by the Tables, Mathes equations, Simple total average and Marginal Production curves. It can also be represented by input - output tables.

COST CURVES:
In production process, There are three types of cost considered: 1. Total Cost Curves: This represents the total cost of
production. It is divided into Total Fixed Cost (TFC) and Total Variable cost (TVC)

2. Average Cost:

TC/ Total no. of units produce. It is a cost per unit of commodity Produced. It is divided into Average Fixed Cost (AFC) and Average Variable Cost (AVC).

3. Marginal Cost: Marginal cost is the additional

made to the total cost as a result of producing an extra unit of output.

NO. of units

Total Cost ‘(TC)

Average Cost Marginal cost (AC) (MC)

1 2 3 4 5 6 7 8 9 10

10 20 25 28 30 52 85 110 220 400

10.00 10.00 8.34 7.04 6.04 8.06 12.14 13.74 24-44 40.00

10 10 5 3 2 22 33 55 110 180

Total cost rising but at a diminishing rate. TC is rising upwards from left to right
Y
TC

Y

MC

AC
Total cost
Q

0

Units of Output
T C = Total Cost

z

AC & MC
0 Units of Output
Ac = TC/Q; AC is sum of MC= TC/ TQ AFC+ AVC

z

AC curve is “U” shaped , MC curve is “U” shaped MC curve insects the AC curve at the lowest point of AC curve

Break Even Analysis
It is very useful technique of profit planning and control Profit maximization, main objective of any firm/co. Profit can not be lest to chance or luck. Proper technique is very important for profit earning. Two main techniques for profit planning and control
(a) (b) The Break- Even Analysis The Ratio Analysis

Break Even analysis revels the relationship between the volume of cost of production on one hand and revenue & Profit obtain from Sales on other. Break Even analysis indicates at what level cost & revenue are in equilibrium. Here BE Point is very Important.

Break Even Point:At the Break Even point TR =Total expenses: It is point of zero profit. At this point firms TC=TR. Produces less to this firm would incurs losses: If it produces & sales more than BE Point it makes profit. The figure shows effects of changes in output on COST, RVENUE, & PROFIT. TC & TR curves --- Linear

Y
RO P

TR
FI T

Cost Revenue, Price (Rs)

BEP

ET N

TC

Variable cost L o s s 0 FC

Fixed Cost

Q Units of output

X

The figure shows effects of changes in output on COST, RVENUE, & PROFIT.

Use of B E Chart for following:
1. Break even production Volume 2. Profit Appropriation for given level of output 3. Choice of optimum level of output 4. Impact of the rate of Change in sales on costs and profits.

Consumer Behavior

Price Concept:
• Price denotes the exchange value of unit of a good Expressed in terms of money. • No unique price for any good – there are multiple price.
– Price – Price – Price – Price of what? of whom? Where? When?

• Price of well defined Product varies over the types of buyer. • Price of good or service also depends up on the place it is received, for that, there is a transport cost • Price while purchasing on credit • Price on down payment transaction.

Price of Determinants
• Price of product = Demand and supply of that product.

• Three Situation: (a) Change in demand, Supply constant (b) Change in supply, demand Constant (c) Change in Demand and supply – Uni Directional (d) Change in Demand and supply – Opposite Direction

Price Discrimination
• Three broad forms- referred as degree. (1) First Degree Price Discrimination: Different prices to each of its customers firm would charge each consumer the maximum rice that customer willingly to pay. This maximum price called as customer’s RESERVATION PRICE. This is called first degree price discrimination. First profit maximizing output at the point at which Marginal Revenue = Marginal Cost.

(2) Second Degree Price Discrimination
Practice of charging different prices per unit for different quantities of the same good or services i.e. quantity discounts are an examples of second degree price discrimination.

(3) Third Degree Price Discrimination
Practice of dividing consumers into two or more groups with separate demand curves and charging different prices to each group. - Student Groups – Less price or discounts - Senior citizen – Less price or discount - Normal Group – Market price only.

Consumer Behaviour
How can a consumer with a limited income, decide which goods and services to buy? • Consumer behavior is best understood in three distinct step: (1) Consumer Preferences: to fins way to describe the reason people might prefer one good to another. We will study that. (2) Budget constraint: Limited income- as such prices of goods and services – Restriction in buying goods. (3) Consumer choices: Given their preferences and limited income consumer choose to buy combination of goods that maximize their satisfaction These three steps of basics of consumer theory. When number of goods and services are available, consumer will see its ability and prices. •

• Three basic assumptions about people’s preferences:
(1) Completeness: Consumer compares the basket and
select the compete basket or both basket are OK, he will remain indifferent by ignoring cost.

(2) Transitivity: preferences are transitive – means that if (3) More is better than less: Goods are assumed to be
desirable – be good so, consumer always prefer more of any good to less. More is always better even if just a litter better. Some good like air pollution, may be undesirable, and consumer will always prefer less.

consumer preference basket A to B and B to C Basket then consumer also prefers A to C

Pricing Methods:

Cost Based

Come. Based

Demand Based

Strategy Based

Full Cost

Cost Plus

Marginal Cost

Going Rate

Sealed Rate

Dual Pricing

Price Price Skimming Price Penetration Discrimination

Govt. Intervention and Pricing.
Government Intervention

Direct

Indirect

Price Pegging

Price of Floors/ Ceiling.

taxes

Subsidies

All Out put

Partial / Dual Pricing

Sales

Profile

Real Estate

Specific

Change in demand, supply Constant.
A = increase in D
B = increase in D

s1
P1 P2
D2 D1 P1 P2 D1

S1

D2

O

Q2

Q1

O

Q2

Q1

Change in supply , demand Constant.
S1 S2 P1 P2 D1 Q1 Q2 Q2 Q1 S2 S1 P2 P1 D1

A= increase in supply

B= decrease in supply

Change in demand & supply: unidirectional
B = decrease in both S4

A= Increase in both s1 P4 P1 P2
D 1 D2 D3 P4 P1 P2

S3 S2 S1 D1

S2

D4

D2

Change in demand & supply: Opposite directional
S 4 P4 P3 P2 D 2 P1 S 1 S 3 S 2

0

Q1

Q 2

Q 3

Q 4

0

Q4

Q3

Q2

Q1

S1 S2 P1 P2 P3 P4 D 3 D1 D2

0

Q 3

Q 1

D 1
Q 2

D4 0 Q Q 4 1 Q 2

A= Increase in D Decrease in S

B= Increase in S Decrease in D

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

ECONOMIC COST EXPLICIT AND IMPLICIT COSTS OPPORTUNITY COST NORMAL PROFIT HISTORICAL & REPLACEMENT COST INCREMENTAL & SUNK COSTS FIXED AND VARIABLE COSTS SEPARABLE &COMMOM COSTS PRIVATE & SOCIAL COSTS TOTAL, AVERAGE & MARGINAL LONG RUN & SHORT RUN

Cost Concepts

1

2

3

4

Economic Cost : The economic cost that a firm incurs in the production of a good refer to the payments it must make to all resource ( factors of production) employed by it in the production of good. Explicit & implicit cost: Explicit cost stands for the payment that must be made to the hired factors hired from outside the control of the firm. Implicit costs is a non cash cost, refers to the payment made to the self owned resources used in the production. Opportunity Cost : -- Opportunity cost is a loss of the reward in the next best use of that source. It should be noted that the ‘reward’ includes both monetary as well as non monetary and the true opportunity cost of a factor may not be exactly known but may be possible to impute. Normal profit : Normal profit is a economic jargon. The normal profit is a component implicit cost.

5

6

7

8

Historical & Replacement Cost :- The cost incurred at the time the asset was acquired. While replacement Stands for the cost which must be incurred if the asset is to be purchased today. The two concept differs due to price variations over time. Incremental and Sunk cost : - Incremental costs are the costs which vary with the decision . In contrast , Sunk costs are the costs which are in varience with the decision. The cost of the time of faculty, administrator, clerk cum peon, and the amount spent on electricity bill, chalk, .etc. will be the incremental costs and the cost of the class room and black board would be the sunk cost Fixed and Variable costs : - In the short run, some cost which do not vary as output varies, while there are which move up and down as output increases and decreases. The former are called the fixed costs and the later the variable costs. Separable and Common costs :-- Costs are also classified on the basis of their traceability. The costs which can be attributed to a product, a department, or a process are the separable costs, and the rest are non separable or common costs.

9.

Private and Social Costs : -- Private costs refer to the costs incurred by an individual firm while Social costs stands for the costs incurred by the society as a whole. The former is the sum total of explicit and implicit costs that a firm incurs in the production of a good. 10. Total, Average & Marginal costs : - Total cost (TC) is the sum of total of explicit and implicit costs. The average cost concept is of relevance for estimating profit margin per unit of sales Total costs concepts is useful for breakeven and profit analysis. The average cost concept is of relevance for estimating profit margin per unit. The marginal cost concept is of significance in deciding the optimum level of output. 11. Long Run & Short Run Costs :-- Long and short run costs are related to long and short production functions. The former refers to costs when all factors of production are subject to change, while the latter stands for costs when at least one of the factors of production is fixed. In the long run all costs are variable costs while in the short run, some costs are fixed and some are variable.

COST FUNCTION
Cost incurs by Firm for production of goods & services depends on two things: (a) Firm’s Production Function (b) Market’s Input’s Supply Functions Cost Function: C = f (Q, E1, P1,) f1,f3>0>f2 Where: C= Total (production) cost Q= Total output E1 = Efficiencies of inputs P1 = Prices of input An increase in price and other things remains same – would lead to an increase in the cost of production.

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