PRODUCER BEHAVIOUR AND
SUPPLY
UNIT 3
PRODUCTION AND COSTS
• Production is the process by which inputs are
transformed into ‘output’.
• Production is carried out by producers or
firms.
• A firm acquires different inputs like labour,
machines, land, raw materials etc. It uses
these inputs to produce output.
Point to
ponder
Production includes not only
production of physical goods like
cloth, rice, etc., but also
production of services like
those of a doctor, teacher, lawyer,
etc.
In order to Once output has The difference
acquire inputs a been produced, between the
firm has to pay the firm sell it in revenue and
for them. This is the market and cost is called the
called the cost earns revenue. firm’s profit.
of production.
We assume that the objective of a
firm is to earn the maximum profit
that it can.
The production function of a firm is the technical
relationship between inputs used and output produced
by the firm.
The production function is represented as:
Q= f(L,K)
Example: A firm is manufacturing chairs with the help of
two inputs say labour and Capital.
250=f(7L,2K)
• A production function deals only with
the efficient use of inputs. Efficiency implies that
it is not possible to get any more output from
the same level of inputs.
• It is the technological knowledge that determines
the maximum levels of output that can be
produced using different combinations of inputs.
If the technology improves, the maximum levels
of output obtainable for different input
combinations increase.
Short run
• It refers to a period in which output can be
changed by changing only variable factors.
• The factor that remains fixed is called the fixed
factor whereas the other factor which the firm
can vary is called the variable factor.
• In the short run, some factors are fixed and some
are variable.
• Fixed factors cannot be changed during such a
short span of time.
Long run
• In the long run, all factors of production can
be varied. So, in the long run, there is no fixed
factor.
• A firm in order to produce different levels of
output in the long run may vary both the
inputs simultaneously.
• It is not advisable to define short run and long
run in terms of say, days, months or years. We
define a period as long run or short run
simply by looking at whether all the inputs can
be varied or not.
• It varies from firm to firm and industry to
industry
Product
• Product or output refers to the volume of
goods produced by a firm or an industry
during a specified period of time.
Total product
• Refers to the total quantity of goods produced
by a firm during a given period of time with
given number of outputs.
• Also known as total physical product(TPP) or
total return or total output
• If 10 labourers produce 60 kg of rice, then
total product is 60 kg.
Average product
• Average product refers to output per unit of
variable input. Also known as average physical
product or average return.
• AP=TP/Units of variable factor
Or
TP=AP*units of variable factor
Q.IF total product is 60kg of rice, produced by 10
labourers(variable input),then Average
product AP=????????????
Marginal product
• It refers to the addition to total product when
one more unit of variable factor is employed.
• MPn=TPn-TPn-1
• MP=Change in total product/change in units
of variable factor=ΔTP/ Δn
• TP=ΣMP
Q. Calculate AP and MP
Variable factors Total product
0 0
1 8
2 20
3 28
4 28
5 25
Law of variable proportions
Law of variable proportions
• The law of variable proportion is a widely
observed law of production which takes place
in the short-run.
• The law of variable proportion states that as we
employ more and more units of a variable input,
keeping other inputs fixed, the total product
increases at increasing rate in the beginning
then increases at diminishing rate and finally
starts falling.
Phase I. Phase of Increasing Returns
• It goes from the origin to the point where the
MP curve is maximum .In this phases, TP curve is
increasing at an increasing rate. MP curve rises
and reaches a maximum.
• Reasons. The reasons for increasing returns are:
1. Underutilisation of fixed factor (land),
2. Indivisibility of factors, and
3. Specialisation of labour
Phase II. Phase of Diminishing Returns
• It is the most important phase out of the three
phases.
• Phase II of production ranges from the point
where MP curve is maximum to the point where
the MP curve is zero
• MP curve is positive but declining. TP curve
increases at a decreasing rate and reaches a
maximum.
• A rational producer will always operate in this
phase. The law of diminishing returns operates in
phase II.
Phase III. Phase of Negative Returns
• It covers the entire range over which MP
curve is negative. In this phase, TP curve falls
• A rational producer will not operate in this
phase, even with free labour, because he
could increase his output by employing less
labour.
• It is a non-economic and an inefficient phase.
• Phase I:TP rises at increasing rate.MP
increases.
• Phase II:TP rises at decreasing rate.MP
decreases and is positive.
• Phase III:TP falls.MP becomes negative.
Relationship between AP and MP
Relationship between AP and MP
• As long as MP is more than AP,AP rises.
• When MP=AP, AP is at its maximum.
• When MP is less than AP,AP starts Falling.
(MP falls at a faster rate in comparison to fall in
AP)
