Unit 3 . Microeconomics Chapter 5 . pptx

Short notes

1. Producer Behaviour & Supply Production Function Chapter 5

2. Production There are 4 factors required for production These factors are land, labour, capital and organisation or entrepreneurship A firm or a producer brings together the factors required for producing a commodity and gets a market ready product We could be talking about a farm, an industry, a firm that provides service, a grocery store…. Let us look at an example

3. Production function Say ‘A’ plans to set up a Photo studio – he has to assemble the studio area, get professionals and money required for all of these As it progresses, he has to pay rent, wages and interest for the use of the other 3 factors For himself, his return would be the profit he earns from this venture Together they would be creating a product or output The returns to the factors would be rent, wages and interest This cost payable to the factors can be called as Cost of Production In simple terms Production means converting raw material into finished goods

4. Production Function Relationship between the inputs brought in by the firm and the output created is the production function The production function may be expressed as Q = f(a, b, c, …..) Where Q represents the output while a, b, c…. represent the inputs If any of the inputs change, the output will change Using the production function, one can compute the output if input data is given or vice versa Which means that the maximum output if minimum inputs are given or minimum inputs needed to get a given output It is assumed that technology does not change – if it changes, increased output can be produced with same inputs

5. Concepts of Revenue and Profit Revenue is the amount received by a firm or a producer if its/his output is sold in the market Profit = Revenue – Costs incurred towards inputs Let us now discuss the concepts of Short Run and Long Run Why are the Short run and Long run concepts important ? Short run and long run concepts are important to take decisions regarding which inputs can be changed immediately and which ones will take time This will help producers plan for expansion

6. Short Run Short run is a time period in which some factors of production cannot be changed while some can be changed The factors that cannot be changed are called as fixed factors Eg : Plant and machinery, land, buildings etc. Those that can be changed are called as variable factors Eg : Manpower, capital induction (to an extent) Production can be enhanced by increasing variable factors but only till the maximum capacity of the fixed factors is reached. Fixed factors cannot be changed during the short time that is meant by the term Short run

7. Short run example Let us say a firm has machinery that can produce 15 AC units in a day The firm produces 10 AC units in a day by employing requisite workers basis demand for the product If the demand increases and the firm wishes to increase its production by another 3 units, it can do so by getting necessary raw material and technicians The machinery is the fixed factor while the workers, technicians and raw materials are the inputs in the short run If the demand for the AC units goes up to 20 in a day, the firm cannot meet the output target in the short run because the fixed factor has a limit of 15 units only

8. Long run Long run indicates that period of time by when all factors of production become variable It is time enough for a firm to take stock of all its inputs and change them as required No factor is fixed in the long run Output can be changed by changing all factors of production If we go back to our previous example, the firm can bring in one more machine or buy one which has greater output capacity It can change its business premises to accommodate the machinery It can scout for and bring in more technicians and man power needed for enhanced production It can buy raw materials needed for the new output limit It can also make necessary capital adjustments to necessitate all of the above

9. Differences between short run and long run In the short run factors of production can be classified as fixed or variable In the short run output can be changed by changing only the variable inputs Supply cannot be increased immediately and hence demand is very responsive Prices can be actively changed basis demand All factors are variable in the long run – no factor is fixed In the long run all factors changed in accordance with the required output Supply and demand can both me responsive and hence both play a role in fixing prices of the commodity

10. Fixed and Variable factors Fixed factors are those which cannot be changed in the short run Eg : Plant and machinery, land, buildings, technology etc Fixed factors do not change or vary directly with output The costs incurred on fixed factors will not vary depending on their usage Variable factors are those which can be changed in the short run Eg : Labour costs, raw material, power charges etc. Variable factors vary directly in relation to output They increase or decrease depending on their usage

11. Product concepts When we talk about product, we mean output It refers to the volume of commodity produced by a firm in a given period We will be discussing three concepts Total Product Marginal Product Average Product

12. Total Product When a firm changes one input keeping all other inputs as constant , the output changes on the basis of the change in the variable input This relationship is referred to as Total Product of the variable input Total Product can also be referred to as the total quantity of goods produced by a firm with the given inputs or resources at a given time Total Product is also called as Total Return or Total Physical Output or Total Output

13. Average Product Average Product is the output per unit of variable input Average Product (AP) = Total Product/ No. of units of variable input We can show Total Product in terms of Average product as Total Product = Average Product x Units of variable factor Average Product can also be called Average Return or Average Physical Product Eg : If Average Product = 50 and Units = 10, then Total Prpduct = 50*10 = 500

14. Marginal Product Marginal Product is the change in output per unit change in input when all other inputs are constant In other words, Marginal Product refers to addition to total product when one more unit of variable input is made Marginal Product of nth unit = Total product of nth unit – Total product of (n-1) th unit Marginal Product is also called as Marginal Return or Marginal Physical Product

15. Law of Variable Proportions The Law of Variable Proportions says that when we increase quantity of one factor keeping all other factors constant, the Total Product Increases initially at an increasing rate Then at a decreasing rate And then at a negative rate The three stages to the LVP can be simplified as follows Stage 1 TP at increasing rate & MP increases Stage 2 TP at decreasing rate & MP falls Stage 3 TP and MP becomes negative It means that adding variable input continuously will lead to rise in MP initially, fall in MP in the next stage and negative in the last stage  

16. Example for LVP Fixed factor Variable factor Total Product (units) Marginal Product (units) Stage of LVP Constant           1 5 5 1 2 15 10 1 3 32 17 1 4 44 12 2 5 44 2 6 40 -4 3

17. Graphical representation of the data A rational producer seeks to operate in Phase 2 Phase 1 – scope to improve output Phase 3 - Negative

18. Shapes of the TP, MP and AP curves Total Product Curve is a positively sloped curve Marginal Product Curve is an inverse U – shaped curve or a bell shaped curve Average Product Curve is also an inverse U- shaped curve or a bell shaped curve but its curve is not as steep as that of a MP Curve

19. Relationship between AP and MP When MP > AP, AP rises When MP < AP, AP falls MP becomes – ve but AP is + ve as long as TP is positive When TP and variable factor is given, both MP and AP can be computed and vice-versa Variable factor Total Product (units) Marginal Product (units) Average Product (units) 1 5 5 5 2 15 15 7.5 3 32 17 10.7 4 44 12 11 5 44 8.8 6 40 -4 6.7