PRODUCTION ECONOMICS Jibgar Joshi

5/8/2013

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Explicit costs of production Implicit costs Profits Accounting profit and pure economic profits Fixed inputs Variable inputs Marginal physical product Law of diminishing returns Economies of scale Diseconomies of scale
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5/8/2013 3 . Implicit costs: opportunity costs of using resources owned by the owners of the firm. workers and others who do not share the ownership of the firm.Explicit costs and Implicit costs • Explicit costs: opportunity costs that take the form of • payments to outside suppliers.

Business: Total revenue minus total costs during a specified time period Economics: Excess over returns to capital. land and labour Excess over interest.Profit Profit means the difference between a firm's total revenues and its total costs (implicit as well as explicit costs). rent and wages. • Accounting profit: total revenue minus explicit costs • Pure economic profit: accounting profit minus implicit costs. 5/8/2013 4 .

Profit is mistaken as the sum of implicit wages of managers/owners. monopoly profit. “pure” profit would not exist. Entrepreneurial profit. windfall profit. Any profit will lead to an increase in output that will lead to a fall in price and the profit will be squeezed out. In conditions of competitive equilibrium. 5/8/2013 5 . rent on land owned by the firm and interest on the capital invested by the owners of the firm.

6 5/8/2013 . Marginal physical product: the amount of output expressed in physical units produced by each added input of one variable input. Law of diminishing returns: The principle that as one variable input is increased. • Variable inputs: that can easily be varied in a short • • • time in order to increase or decrease the output.• Fixed inputs: that can not be changed in a short time. with all others remaining fixed. a point will be reached beyond which the marginal physical product of the variable input begins to decrease. other things being equal. Marginal cost: the increase in cost required to increase the output of some good or service by one unit.

Diseconomies of scale: a phenomenon said to occur whenever long run average cost increases as output increases.Economies of scale • A phenomenon said to occur whenever long run • • average cost decreases as output increases. Constant returns to scale: no economies of scale or diseconomies of scale. 5/8/2013 7 .

It is the opportunity foregone • Cost to the individual • Cost to the society as a whole • Private good vs. 5/8/2013 8 . social/public good By definition. demand for public good is collective.Opportunity or social costs The social cost of a factor of production is its cost in the best alternative use. Others cannot be excluded from its use and it is not traded. a public good can be enjoyed without diminishing its supply. it is the sum of the separate demands of individuals for the good. As a result of being non-rivalry.

and distribute income.Market and Valuation • Market: where buyers and sellers meet. Market imperfections Market failures Market vs. the urban poor Use value vs. market goods 9 5/8/2013 . exchange value Private goods vs. public goods Welfare goods vs. provide incentives. public institutions Monetary values for comparison Social equity. transmits • • • • • • • • information.

This leads to a resource allocation. Activities can impose losses or gains on the welfare of the people other than those engaged in the activities. This is also a cause of market failure. they are not accounted for in market-based allocation. This is described as market failure. They fail to lead the economic process towards the social optimum.Market Failure • Although markets can be made to achieve efficient • allocation. 10 5/8/2013 . It can occur when markets do not exist or when they fail to communicate information. It is not easy to value them and enter into market prices. they are unable to do so. As a result. If these losses or gains go uncompensated or unpaid for. It can also occur due to restrictions in the market operation and lack of institutions or regulations. which is less than the social optimum. they are described as externalities.

External economics • Competitive markets • Capital stock • Labour deployment Urban growth • Use of resources outside the urban boundary • Primacy and economic domination • Economic base •5/8/2013 Competitiveness 11 .Internal and external economics and urban growth Internal economics • Efficient production system • Equitable distribution • Convergence of private goods and public goods • Ability to satisfy needs over time.

Laws of demand and supply 5/8/2013 12 .

It depends on: • Commodity’s own price • The prices of other commodities • The costs of factors of production • The goals of the firm • The state of technology It increases if the price of the commodity increases. ceteris paribus. It is a flow expressed as so much per period of time. a movement along a supply curve indicates a change in the quantity supplied in 5/8/2013 13 response to a change in price.Supply The amount of a commodity that a firm wishes to sell is called the quantity supplied. Quantity supplied is assumed to increase as the price of the commodity increases. .

the distribution of income among households and the size of the population. The quantity of demand is determined by: • The commodity’s own price • The price of the related commodities • Average household income • Tastes • The distribution of income among households • The size of the population 5/8/2013 14 . This quantity is determined by the commodity’s own price. The prices of related commodities. tastes.Demand The amount of a commodity that households wish to purchase is called the quantity demanded. It is a flow expressed as so much per period of time. average household income.

a fall in demand lowers equilibrium quantity but raises equilibrium price.Quantity demanded is assumed to increase as the price of the commodity falls. 5/8/2013 15 . A movement along a demand curve indicates a change in the quantity demanded in response to a change in the price of the commodity. A rise in demand raises both equilibrium price and quantity. The relationship between quantity demanded and price is presented graphically by a demand curve that shows how much will be demanded at each market price. ceteris paribus.

The demand curve shifts to the right (an increase in demand) if • Average income rises • The prices of the substitute rises • A price of a complement falls • Population rises • There is a change in the taste in favour of the product The opposite changes shift the demand curve to the left. A shift of a demand curve represents a change in the quantity demanded in each price and is referred to as a change in demand.Demand and supply curve Using the method of comparative statistics. the effects of a shift in either demand or supply can be determined. 5/8/2013 16 .

5/8/2013 17 .The supply curve shifts to the right (an increase in supply) if • the prices of other commodities fall • The costs of producing the commodity fall • Producers become more willing to produce the commodity The opposite changes shift the supply curve to the left. A shift of a supply curve represents a change in the quantity supplied in each price and is referred to as a change in supply.

A fall in its relative price means that its price rises by less than does the price level. 5/8/2013 18 .Price determination Price theory is most simply explained against a backdrop of a constant price level. a rise in the relative price of one commodity means that its price rises more than does the price level. there will be neither shortage nor surplus and price will not change until either the supply curve or the demand curve shifts. Price is assumed to rise when there is a shortage and to fall when there is a surplus. Thus the actual market price will be pushed toward the equilibrium price. and when it is reached. In an inflationary period. Price changes discussed in the theory are changes relative to the average level of all prices.

Actual market price will be pushed towards the equilibrium. 19 5/8/2013 . A fall in supply lowers e-quantity and raises e.Equilibrium Price • Is the one at which the quantity demanded equals the • quantity supplied.price. When it is reached there will be neither shortage nor surplus. Price will not change until the supply or the demand curve changes A rise in demand raises both e-price and quantity and a fall lowers both. At any price below the equilibrium there will be excess demand while at any price above the equilibrium there will be excess supply. A rise in supply raises e-quantity and lowers e. Price is assumed to rise when there is a shortage and to fall when there is a surplus. These are the laws of supply and demand. Graphically equilibrium occurs where demand and supply curves intersect.price.

) 14 10 7 5 3 2 Quantity of Demand 1 2 3 4 5 6 Supply 6 5 4 3 3 1 5/8/2013 20 .Price (Rs.

) Supply Demand 2 3 4 5 6 21 Demand/Supply .Demand and Supply Curve 16 14 12 10 8 6 4 2 0 1 5/8/2013 Price (Rs.

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