ECONOMICS FOR MANAGERS

COURSE NO : 401

Rup Ratan Pine

Mob: 01552438118
Email: ahirmrittika@yahoo.com
SUPPLY
 Supply

Supply is an economic term that refers to the amount of a given product or service that suppliers are willing to
offer to consumers at a given price level at a given period. When the price of a product is low, the supply is
low. When the price of a product is high, the supply is high.

Sx = f (Px, Pa… Pc, PL… PO, T, Cr, St, O, G),

Px → own price of good x,

Pa … Pc → prices of related goods,
PL … PO→ prices of inputs,
T → time,
St → the state of technology,
O → objectives of the firm, and
G → taxes, subsidies and regulation
Determinants of Supply
 Supply Schedule
Market Supply Schedule
 
In the table below the produce are able and willing to offer for sale 100 units of a commodity at price of Tk.4. As
the price falls, the quantity offered for sale decreases. At price of Tk.1, the quantity offered for sale is only 40
units.

(In Tk.)

Px 5 4 3 2 1

QxS 100 80 60 40 20
 Supply Curve

The supply curve is a graphical representation of the relationship between the price of a good or service and the
quantity supplied for a given period of time. In a typical representation, the price will appear on the left vertical
axis, the quantity supplied on the horizontal axis.
Movement along the supply curve
 Shift in Supply Curve

Supply Curve Shifting to the Left Supply Curve Shifting to the Right
 Law of Supply
The law of supply is a fundamental principle of economic theory which states that,
all else equal, an increase in price results in an increase in quantity supplied.

In other words, there is a direct relationship between price and quantity: quantities
respond in the same direction as price changes.
 Elasticity of Supply

Responsiveness of producers to changes in the price of their goods or services. As a general rule, if prices rise so does
the supply.

Elasticity of supply is measured as the ratio of proportionate change in the quantity supplied to the proportionate
change in price. High elasticity indicates the supply is sensitive to changes in prices, low elasticity indicates little
sensitivity to price changes, and no elasticity means no relationship with price. Also called price elasticity of supply.

Measurement and Formula:

Es = Percentage Change in Quantity Supplied

        Percentage Change in Price
 
It can also be written as:

Es = ΔQ/Q
        ΔP/P
 Es = ΔQ x P
        ΔP    Q
 
 Equilibrium Price & Quantity Demanded
• The logic of the model of demand and supply is simple. The demand curve shows the quantities of a particular
good or service that buyers will be willing and able to purchase at each price during a specified period.

• The supply curve shows the quantities that sellers will offer for sale at each price during that same period.

• By putting the two curves together, we should be able to find a price at which the quantity buyers are willing and
able to purchase equals the quantity sellers will offer for sale.
 Equilibrium Price Quantity Demanded

• The Determination of Equilibrium Price and Quantity combines the demand and supply curve. Notice that the
two curves intersect at a price of $6 per pound—at this price the quantities demanded and supplied are equal.
Buyers want to purchase, and sellers are willing to offer for sale, 25 million pounds of coffee per month. The
market for coffee is in equilibrium. Unless the demand or supply curve shifts, there will be no tendency for price
to change.
• The equilibrium price in any market is the price at which quantity demanded equals quantity supplied.
• The equilibrium price in the market for coffee is thus $6 per pound.
• The equilibrium quantity is the quantity demanded and supplied at the equilibrium price. At a price above the
equilibrium, there is a natural tendency for the price to fall. At a price below the equilibrium, there is a tendency
for the price to rise.
Equilibrium Price Quantity Demanded
 Surplus and Shortage
• A surplus is the amount by which the quantity supplied exceeds the quantity demanded at
the current price.

• A shortage is the amount by which the quantity demanded exceeds the quantity supplied at
the current price.
Surplus
Shortage
PRODUCTION
ANALYSIS
 PRODUCTION ANALYSIS
 Production is concerned with the way in which resources or inputs such as land, labor, and machinery are
employed to produce a firm’s product or output.

 Production may be either services or goods.

 To produce the goods we use inputs. Basically inputs are divided into two types. those are fixed inputs and
variable inputs.

 Fixed inputs are the inputs that remain constant in short-term. Variable inputs are inputs, which are variable
in both short-term and long-term.
 Production Function
Production function expresses the relationship between inputs and outputs.
Production function is an equation, a table, a graph, which express the relationship between inputs
and outputs.
Production function explains that the maximum output of goods or services that can be produced
by a firm in a specific time with a given amount of inputs or factors of production.
Production Function: Q = f (L, M, N, C, T̅)
We are producing Q quantities of goods by employing K capital and L labor.
Here
Q Represents quantity of goods
L Represents Labor employed,
M Represents Management (of organization),
N Represents (or natural resources)
C Represents Capital employed
T̅ Represents Technology
Factors of Production
 Total, Average and Marginal Product

Total Product (TP):

Total product of a factor is the amount of total output produced by a given amount of the factor, other factors
held constant. As the amount of a factor increases, the total output increases.
Average Product (AP):
Average product of a factor is the total output produced per unit of the factor employed. Thus,
Average Product = Total Product/Number of units of a factor employed
If Q stands for total product, L for the number of a variable factor employed, then average product (AP) is
given by: AP = Q/L
Marginal Product (MP):
Marginal product of a factor is the addition to the total production by the employment of an extra unit of a
factor.
Mathematically, if employment of labour increases by ∆L units which yield an increase in total output by
∆Q units, the marginal physical product of labour is given by ∆Q/∆L. That is, MPL = ∆Q/∆L
Total, Average and Marginal Product
 Short-Term production function

Short-Term production function is a function, which we are producing goods in the short-term by
employing two inputs that are :
Capital (C) : It is fixed input which is constant in the short-term.
Labor (L) : It is variable input in the short-term.

In the short-term we are producing only one product by employing two inputs. The two inputs are capital
(C) and labor (L).

In the short term we will increase L input and we will keep C as constant.
 Short-Term Production Function
Units of C
Output Quantity
Employed
8 37 60 83 96 107 117 127 128

7 42 64 78 90 101 110 119 120

6 37 52 64 73 82 90 97 104

5 31 47 58 67 75 82 89 95

4 24 39 52 60 67 73 79 85

3 17 29 41 52 58 64 69 73

2 (8) (18) (29) (39) (47) (52) (56) (52)

1 4 8 14 20 27 24 21 17

1 2 3 4 5 6 7 8

Units of L employed
 Short-Term Production Function

We can observe in the table, we are producing 8 quantities of goods by employing 2 capital and 1 labor.
Here, when we increased labor 1 to 2, output was 18. When we increased labor from 2 to 7 the total output
reached to 56 quantities with constant C=2 capital.

After certain point of time (L=8) the output started to decease i.e. 52.

In this case we have to understand, in the short-term by increasing labor without increasing capital, after certain
level, the output starts to decrease. The reason to decrease the output is The Law of Diminishing Returns.
 The Law of Variable Proportions/Diminishing Return
• Law of Variable Proportions explains that when more and more units of a variable input are employed on a
given quantity of fixed inputs, the total output may initially increase at increasing rate and then at a constant
rate, but it will eventually increase at diminishing rates.
• In other words, the total output initially increases with an increase in variable input at given quantity of
fixed inputs, but it starts decreasing after a point of time.
 Stages of Production
The short-run production function can be divided into three distinct stages of production.
Stage-I: Increasing Returns:
 In stage I, the average product reaches the maximum and equals the marginal product. This stage is portrayed in
the figure from the origin to point E where the MP and AP curves meet.
 In this stage, the TP curve also increases rapidly. Thus this stage relates to increasing average returns. Here land
is too much in relation to the workers employed. It is, therefore, uneconomical to cultivate land in this stage. 
 The main reason for increasing returns in the first stage is that in the beginning the fixed factor is large in
quantity than the variable factor. When more units of the variable factor are applied to a fixed factor, the
fixed factor is used more intensively and production increases rapidly.
 It can also be explained in another way. In the beginning the fixed factor cannot be put to the maximum use
due to the non-applicability of sufficient units of the variable factor. But when units of the variable factor are
applied in sufficient quantities, division of labour and specialization lead to per unit increase in production
and the law of increasing returns operate.
 Another reason for increasing returns is that the fixed factor is indivisible which means that it must be used in a
fixed minimum size. When more units of the variable factor are applied on such a fixed factor, production
increases more than proportionately. This cause points towards the law of increasing returns.
 Stages of Production
Stage-II: Diminishing Returns:
 In between stages I and III is the most important stage of production that of diminishing returns. Stage II
starts when the average product is at its maximum to the zero point of the marginal product. At the latter
point, the total product is the highest.

 Thus the total product increases at a diminishing rate and the average and marginal products decline.
Throughout this stage, the marginal product is below the average product. This is the only stage in which
production is feasible and profitable.

 Hence it is not correct to say that the law of variable proportions is another name for the law of diminishing
returns. In fact, the law of diminishing returns is only one phase of the law of variable proportions.
 Stages of Production
Stage-III: Negative Marginal Returns:
 Production cannot take place in Stage III either. For, in this stage, total product starts declining and the marginal
product becomes negative. The employment of the 8th worker actually causes a decrease in total output from
56 to 52 units and makes the marginal product minus 4.

 In the figure, this stage starts from the dotted line FC where the MP curve is below the X- axis. Here the
workers are too many in relation to the available land, making it absolutely impossible to cultivate it. To the right
of point F, the variable input is used excessively. Therefore, production will not take place in this stage.
 The Long-Run Production Function

In the long run, a firm has time enough to change the amount of all of its inputs. Thus, there is really no
difference between fixed and variable inputs.
It has been observed that when there is a proportionate change in the amounts of inputs, the behavior of
output varies. The output may increase by a great proportion, by in the same proportion or in a smaller
proportion to its inputs. This behavior of output with the increase in scale of operation is termed as
increasing returns to scale, constant returns to scale and diminishing returns to scale. These three laws
of returns to scale are now explained, in brief, under separate heads.
(1) Increasing Returns to Scale:
If the output of a firm increases more than in proportion to an equal percentage increase in all inputs, the
production is said to exhibit increasing returns to scale.
For example, if the amount of inputs are doubled and the output increases by more than double, it is
said to be an increasing returns to scale. When there is an increase in the scale of production, it leads to lower
average cost per unit produced as the firm enjoys economies of scale.
 Returns to Scale

(2) Constant Returns to Scale:

When all inputs are increased by a certain percentage, the output increases by the same percentage, the
production function is said to exhibit constant returns to scale.

For example, if a firm doubles inputs, it doubles output. In case, it triples output. The constant
scale of production has no effect on average cost per unit produced.

(3) Diminishing Returns to Scale:

The term 'diminishing' returns to scale refers to scale where output increases in a smaller proportion
than the increase in all inputs.
For example, if a firm increases inputs by 100% but the output decreases by less than 100%, the firm is
said to exhibit decreasing returns to scale. In case of decreasing returns to scale, the firm faces diseconomies
of scale. The firm's scale of production leads to higher average cost per unit produced.
Returns to Scale
Returns to Scale
 Economies of Scale

• Economies of Scale:
As a result of increasing production the production cost is low, and it is known as economies of scale.
As long as the output is increased in the long run, the cost of production will be at minimum level, this
is known as economies of scale, Economies of scale is divided into two parts.
1.    Internal Economies
2.    External Economies

• Internal Economies:
Internal economies are those benefits or advantages enjoyed by an individual firm if it increases its
size and the output.
 Forms of Internal Economies
Labors Economies : A large firm can attract specialist or efficient labors and due to increasing
specializations the efficiency and productivity will be increased, leading to decrease in the labors
cost per unit of output.

Technical Economies: A large firm can adopt and implement the new and latest technologies,
which helps in reducing the cost of manufacturing process, whereas the small firm may not have the
capacity to implement latest technologies. A large firm can make optimum utilization of machinery, and
it can manage the production activities in continuous series without any loss of time thereby saving
the time and transportation cost.

Managerial Economies: The managerial cost per unit will decrease due to mass scale production.
Like, the salary of general manager, which remains the same whether, the output is high or low. Moreover,
a large firm can recruit the skilled professionals by paying them a good salary, but a small firm does not
have the much of capacity to pay high salaries. Thus, mass scale of production will decrease the
managerial cost per unit.
 Forms of Internal Economies
Marketing Economies: A large firm can purchase their requirements on a bulk scale therefore, they
get a discount. Similarly the advertisement cost will be reduced because a large firm produces a
variety of different types of products. Moreover, a large firm can employ sales professional for
marketing their products effectively.

Financial Economies: A large firm can raise their financial requirements easily from different sources
than a small one. A large firm can raise their capital easily from the capital market because the investor
has more confidence on the large firm than in small firm.

Risk Bearing Economies: The large firm can minimize the business risk because it produces a variety
of products. The loss in one product line can be balanced by the profit in other product line.
 External Economies

External Economies are those benefits, which are enjoyed by all the firms in an industry irrespective of their
increased size and output. All the firms in the industry share external economies.
Economies of Localization: When all the firms are situated at one place, all the firms will be enjoying the
benefits of skilled labors, infrastructure facilities and cheap transport thereby reducing the manufacturing cost.

Economies of Information: All the firms in an industry can have a common research and development
center through which the research work can be undertaken jointly. They can also have the information related
to market and technology.

Growth of subsidiary Industry: The production process can be divided into different components.
Specialized subsidiary firms at a low cost can manufacture each component.

Economies of By-Products: The waste materials released by a particular firm can be used as an input by the
other firm to manufacture a by-product.
 Iso-Product/Iso- Curve
• An Iso-product or Iso-quant curve is that curve which shows the different combinations of two factors
yielding the same total product. Like, indifference curves, Iso- quant curves also slope downward from left to
right.
 Iso-Product Map
• An Iso-product map shows a set of iso-product curves. A higher iso-product curve represents a higher level of
output. In Fig. we have family iso-product curves, each representing a particular level of output.
 Iso-Cost Line/Curve
The isocost line/curve is an important component when analysing producer's behaviour. The isocost
line illustrates all the possible combinations of two factors that can be used at given costs and for a
given producer's budget. In simple words, an isocost line represents a combination of inputs which
all cost the same amount.
 Optimal Input Combination

The isocost line is combined with the isoquant map to determine the optimal production point at any given level
of output. Specifically, the point of tangency between any isoquant and an isocost line gives the lowest-cost
combination of inputs that can produce the level of output associated with that isoquant.
 Optimal Input Combination

• Here the isocost line CD is tangent to the iso-product curve 400 units at point Q. The firm employs OC units of
factor Y and OD units of factor X to produce 400 units of output. This is the optimum output which the firm
can get from the cost outlay of Q. In this figure any point below Q on the price line AB is desirable as it shows
lower cost, but it is not attainable for producing 400 units of output. As regards points RS above Q on isocost
lines GH, EF, they show higher cost.
•  These are beyond the reach of the producer with CD outlay. Hence point Q is the least cost point. It is the
point which is the least cost factor combination for producing 400 units of output with OC units of factor Y
and OD units of factor X. Point Q is the equilibrium of the producer.

• At this point, the slope of the isoquants equal to the slope of the isocost line. The MRT of the two inputs equals
their price ratio.
• Thus we find that at point Q, the two conditions of producer's, equilibrium in the choice of factor
combinations, are satisfied.
 Expansion Path
An expansion path (also called a scale line) is a curve in a graph with quantities of two inputs, typically capital and
labor, plotted on the axes. The path connects optimal input combinations as the scale of production expands.

A producer seeking to produce the most units of a product in the cheapest possible way attempts to increase
production along the expansion path.

The points on an expansion path occur where the firm's isocost curves, each showing fixed total input cost, and its
isoquants, each showing a particular level of output, are tangent; each tangency point determines the firm's
conditional factor demands. As a producer's allowable total cost increases, the firm moves from one of these
tangency points to the next; the line joining the tangency points is called the expansion path.
Expansion Path
 Managerial Uses Of Production Function

Production functions are logical and useful.

Production analysis can be used as aids in decision making because they can give guidance to obtain the
maximum output from a given set of inputs and how to obtain a given output from the minimum
aggregation of inputs.
The complex production functions with large numbers of inputs and outputs are analyzed with the
help of computer based programmes.