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/ 46
I B.Com (Semester - Il} Principle of Economics 91
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Essay Questions
( 1. Define Cost? Explain the classification (types) of cost.
Ans: The Cost of production is the expenditure that is incurred by a
firm or a producer. The expenses are important from the point of
view of the producer because the price ofa commodity should cover
these costs. Otherwise the producer cannot afford to carry on the
business. Thus the concept of cost is related to production. The
remuneration paid to the different factors of production, the
expenditure incurred on raw-materials machinery, factory buildings,
electricity etc. are treated as costs of productions.
Types of Costs: There are different concepts of costs. It is
important to distinguish them.
1. Money Costs: The most widely accepted concept of cost
is the money cost of production. Money costs are related to the
money expenses of a firm. These are entrepreneur’s costs of
producing a commodity. This include wages and salaries of labour,
interest on capital, rent paid to the owners of land, cost of raw material,
replacement charges of machinery, normal profits of entrepreneur,
expenses on power, light, fuel, advertisement, transportation,
insurance charges and all types of taxes.
2. Real Costs: Adam Smith regarded pains and sacrifices of
labour as real cost. Marshall thought that the efforts and sacrifices
undergone by various members of society in producing a commodity
are the real costs. According to him the real cost of production is not
expressed in money but in efforts (of workers) and sacrifices (of
capitalists) which have undergone in producing a commodity. He
treated it as social cost. There is no reference of money in this concept.
Only efforts and sacrifices of individuals are treated as costs. Producer Equilibrium CC
3. incremental Costs:Incremental costs are addition to the
total cost due to a change in the nature of level ofbusiness activity.
Eg. Addition ofa new product, new machine, entering into a new
market etc.
4. Marginal cost:It is the addition to the total cost by
producing one more unit. MC curve is U-shaped tracing the three
phrases of law of variable proportions (short run) or returns to scale.
5. Implicit costs: These are the costs of the factor units owned
by the owner himself. They do not involve cash payments or appear
in books of accounts,the value of next best alternative use of a resource
owned by owner. They are invisible.
6. Explicit Cost:These are the costs which involve cash
payments they are recorded in the books ofaccount. All manufacturing
and trading expenses which involve cash payment are explicit costs.
They are referred to as out of pocket costs.
7. Opportunity Costs:These are equal to the earnings which
a factor of production in alternative use. It is the minimum payment
tobe made toa factor unit to retain it in the present use rather than to
seek employment else where. It is also called transfer price.
8. Fixed costs:The costs incurred on factors of production
which are fixed in the short run eg. Cost of running fixed equipment,
salaries of administrative staff, depreciation of machinery etc. These
are the cost incurred even at zero output. These costs remain fixed
inthe short nun only.
9. Variable Costs:Costs which vary with output are called
variable costs. Inthe long run all costs are variable costs. Examples
of variable costs are cost of raw material, wages of labour, oil fuel
and gas consumed etc.
( 2. Explain the cost output relationship in the short run.
Ans.The distinction between short run and long run does not relate
to calendar period of time. It relates to the conditions of production.
Short run is period during which all factors are not variable. Some
factors are fixed and some are variable. Output can be varied by
varying the variable factors. In the short run new firms cannot enter
the industry nor firms can leave the industry. It B.Com (Semester - Il) Principle of Economics 93
Cost output relation in the short run:The short run is a
period in which the firms cannot change its plant, equipment and the
scale of organization. To meet the increased demand, it can raise
output by hiring more labour and raw materials or asking the existing
labour force to work overtime.
The scale of organization being fixed, the short run Total Costs
(TC) are divided into total fixed costs (TFC) and total variable costs
(TVC)
TC=TFC+TVC
Total Costs:Total costs are the total expenses incurred by a
firm in producing a given quantity or a commodity. They include
payments for rent, interest, wages, taxes and expanses on raw
materials, electricity, water, advertising etc.
Total Fixed Costs:Total fixed costs are those costs of
production that do not change with output. They are independent of
the level of output. In fact, they have to be incurred even when the
firm stops production temporarily. They are also called overhead.
costs.
Total Variable Costs:Total variable costs are those costs of
production that change directly with output. They rise when output
increases and fall when output declines. They are also known as
direct costs.
The following table shown in the total costs
Units Total Fixed Total Variable | Total Cost
Costs (TFOC)(Rs) | Costs (TVOC)(Rs) (tc)(Rs)
0 60 0 60 Producer Equilibrium 0
The above schedule is shown in the following diagram.
TC
y
‘TFC
TFC/TVC/TC
oO
Number of Units x
In the diagram above TFC is total fixed cost curve. It remains
Rs.60 at all levels of output. TVC is total variable cost curve. Total
variable costs are zero, when the output is zero and they continue to
increase with a rise in the output. TC is the total cost curve (TFC +
TVC) and the total cost vary with total variable costs, when the firm
starts producing.
Shortrun average costs:In the short run analysis of the firm,
average costs are more important than total costs. The units of output
that a firm produces do not cost the same amount to the firm. But
they must be sold at the same price. Therefore, the firm must know
the perunit cost or the average cost. The short run average costs of
a firm are the average fixed costs, the average variable costs and
average total costs.
Average fixed cost: From the total fixed cost, average fixed
cost can be find out. Average fixed cost is obtained by dividing the
total fixed cost of the firm with its output.
Average Fixed Cost =__Tolal Fixedeost gnc = TRC
No. of Units produced Q
The average fixed costs diminish continuously as output
increases. This is natural because when a constant figure of total
fixed costs are divided by a continuously increasing unit of output, It B.Com (Semester - Il) Principle of Economics 95
the result is continuously diminishing, average fixed costs. Thus, the
AFC curve is a downward sloping curve which approaches the
quantity axis without touching it.
Average Variable cost:Similarly, average variable cost is
obtained by dividing the total variable cost by the number of units
produced.
Total Variable cost AVC = TVC
Average Variable Cost =———_—_————__.,
No. of Units produced Q
The average variable costs decline with the rise in output as
larger quantities of variable factors are applied to fixed plant and
equipment. But eventually they begin to rise due to the law of
diminishing returns. Thus the AVC curve is U- shaped.
Average total costs:There are the average costs of producing
any given output. They are arrived out by dividing the total costs at
each level of output by the number of units produced.
Total cost _ rc
Average Total Cost =————__——_——___, =
No. of Units produced. Q
Ifaverage fixed cost and average variable cost are added for
each level of output. We get average cost. Thus the SAC curve is
U-shaped
AC= AFC + AVC
Short ran marginal cost:A fundamental concept for the
determination of the exact level of output ofa firm is the marginal
cost. Marginal cost is the additional to total cost by producing an
additional unit of output.
Change in Total Cost _ ATC
SMC= - =—
Change in Output AQ Producer Equilibrium 96
These costs are shown in the following table.
No.of | TFC | TVC
. Ave
AVC / ARC / AC / MC
AFC
Oo x
Number of Units
From the above table marginal, average, average fixed and
variable costs are shown in the following diagram. In the diagrams
below AFC is the average fixed cost curve AVC is the average
variable cost curve. AC is the average cost curve and MC is marginal
cost curve. With the increase in the output the average fixed costs
will continue to fall. The average variable costs are subject to the
law of variable proportions. Therefore, they fall in the beginning,
later they rise with the increase in output. Marginal cost curve falls at
first as the output increase and then slopes upwards indicating the
marginal cost is increasing with the further increase in output. So AC
and MC are U shaped. Marginal cost curve intersects average cost It B.Com (Semester - Il) Principle of Economics 97
curve at its minimum point. The role of marginal cost is very important
in the cost analysis. The producer always compares the cost of the
additional unit produced with the revenue he is getting from that unit.
So long the marginal cost is less than the marginal revenue, the
producer continues to increase the production. If the marginal cost
is more than the marginal revenuc he stops increasing the production.
3. Define Law of Supply and explain the factors
determining Supply.
Ans : Ineconomics, supply during a given period of time means the
quantities of goods which are offered for sale at particular prices.
Thus the supply of a commodity may be defined as the amount of
that commodity which the sellers or producers are able and willing
to offer for sale at a particular price during a certain period of time.
Law of Supply:The law of supply shows the functional
relationship between price and quantity offered for sale. The law of
supply can be stated as follows: “other things remaining the same,
the supply of a commodity extends with a rise in its price and contracts
with a fall in its price”. Thus, there is a direct relationship between
price and supply. The law of supply can be explained with the help
of below schedule and curve.
Price of Goods Quantity
Supplied (Rs.) kg.)
When the supply schedule is plotted on a graph, a supply
curve is obtained. On X axis quantities of supply on Y axis prices
are taken. SS curve is the supply curve. It has a positive slope. It
moves upwards to the right. It shows that large quantity would be
offered for sale at a higher price. Producer Equilibrium 98
wt
Price
° Supply
Supply function:Supply function explains the functional
relation between quantity supplied and determinants of supply ofa
commodity. This can be expressed as follows.
Sy =f (Pee Spo Pps B,0.7 4,8)
S, = Supply of Commodity X
P,, = Price of Commodity X
f = functionof
f, = Prices of factor inputs employed for producing X
P....PL= Prices of related goods
O = factors outside the economic sphere.
T Technology used.
t = Taxation
s = Subsidy
Functional relationship between supply and price stated by
the law of supply holds good only so long as other determinants of
supply remains constant.
Factors determine the supply: Some of the important
factors which determine the supply ofa commodity are:
L. Price of the commodity: The supply of the commodity
depends upon the price of that commodity. Price and supply are
directly related to each other. The lower, the price, the smaller the
supply and higher the price, the larger the supply, supply depends
only upon its own price but also on the prices of substitute and
complementary goods. It B.Com (Semester - Il) Principle of Economics 99
2. The price of factors of production: The cost of
production of acommodity depends upon the prices of various factors
of production. If there is an increase in the price of factors of
production, the production costs would be higher for the same level
ofoutput. There will be a fall in profit and supply will be reduced. In
the same way, a fall in the prices of factors of production would
reduce the cost of production. Thus supply is affected by the prices
of the factors in both cases.
3. The state of technology: An improvement in the
technology leads to reduction in the cost of production which will
increase the supply. All inventions and innovations are aspects of
new and improved technology which increase production and supply
and reduce the cost of production.
4. Price Expectations: The sellers always try to study market
conditions. If they expect that future price will be higher than the
prices at present, they try to reduce the present supply of the
commodity. On the other hand, if they expect a fall in the future price
they try to sell more at the current prices.
5. Entry of new firms:The supply of a commodity depends
upon the number of firms. The larger the number of firms, the more
will be the supply of the commodity.
6. Other Factors: Supply of commodity depends on the goals
and targets of the firms. Weather conditions, floods, droughts,
epidemics etc., do cause fluctuations in the supply of goods.
4. Define Law of Supply and explain the exceptions to
the Law of Supply.
Ans: In economics, supply during a given period of time means the
quantities of goods which are offered for sale at particular prices.
Thus the supply of a commodity may be defined as the amount of
that commodity which the sellers or producers are able and willing
to offer for sale at a particular price during a certain period of time.
Law of Supply:The law of supply shows the functional
relationship between price and quantity offered for sale. The law of
supply can be stated as follows: “other things remaining the same, Producer Equilibrium 100
the supply of acommodity extends with a rise in its price and contracts
witha fall in its price”. Thus, there is a direct relationship between
price and supply.
Exceptions to the Law of Supply: It is said that there are some
exceptions to the law of supply.
1, Producer may anticipate further changes in prices suppose
the price of a commodity has fallen. It is expected to fall further.
Then, firms try to sell more when the price has initially fallen.
2. The law does not apply to labor. For example, the supply
of labor may get reduced as wage rate rises beyond a point. The
labor may be satisfied with a certain level of income. As he gets the
desired level of income, a higher wage rate reduces the supply of
labor. At that point the supply curve of labour bends backward.
3. The supply of agricultural output depends on weather
conditions. Even when the prices have gone up agricultural products
may be in short — supply.
4. In the long — run the tastes and habits are more effective
than prices.
5. Expectations regarding price — changes: If the sellers
think that the price in the future is going to fall, they may sell more at
the lower price itself. More supply at the lower price is contrary to
the law.
6. Labour Supply: \n the case of labour supply, the supply
curve may be backward bending. Some labourers may be satisfied
witha certain minimum income. Until they get that minimum income,
they work more as wages rise. After that they work less. Therefore,
the supply curve goes upward for part of the length and then bends
backwards.
In the diagram the supply curve of labour goes upward until
the wages are W,,. After that the supply of labour falls as wages
increase. So the supply curve bends backwards. It B.Com (Semester - Il) Principle of Economics 101
LS
Wages
2222 2 4
LS
O° Tabour Supply X
But this may be true in the case of some individuals. For the
industry as a whole, the supply curve goes upward.
5. Explain the law of variable proportions with a
suitable diagram, assumptions and importance.
(Or)
Discuss the law of diminishing Marginal Returns
with a suitable diagram.
(Or)
Write the three Stages of Production function through
law of Variable Proportions.
Ans : The law of variable proportions explains the behavior of
production function in the short run. In the short run some factors of
production or inputs are fixed and some factors or inputs are variable.
The firm can vary the output by varying the quantities of one or few
inputs.
When we thus varies the proportion between fixed and variable
factors, what is its effect on output? The answer to this is found in
the law of variable proportions popularly known as the law of
Definiton : According to Alfred Marshall ‘an increase in
capital and labour applied in the cultivation of land causes in general
less than proportionate increase in the amount of produce raised
unless it happens to coincide with an improvement in the art of
agriculture’. Producer Equilibrium 102
According to Stigler “Tt means as equal increments of one
unit ar added; the inputs of other productive service being held
constant, beyond a certain point the resulting increments of product
will decrease, i.e. the marginal product will diminish”.
Assumptions of the law : The law of variable proportionate
holds good under the following conditions.
1. Constant Technology : The state of technology is assumed
tobe given and constant. If there is an improvement in technology,
the production will move upward.
2. Factor proportions are variable : The law assumes that
factor proportions are variable. If factors of production are to be
combined in a fixed proportion, the law has no validity.
3. Homogenous factor units : The units of factor are
homogenous and each unit in quality and amount vary with other
unit.
4. Short run : The law operates in the short run when it is not
possible to vary all factor inputs.
Explanation of the law : The law can be explained with the
help of numerical example. Take the case of a farmer who is cultivating
anacre of land. Assume that the area ofland and his capital equipment
are fixed. He tries to increase output by varying the number of men
i.e., labour. The changes in output, that is total product, average
product and marginal product of labour are shown in the following
table.
Variable | Total Average Marginal
factor | product | product product Stages
(labour) | Quintals) (Quintals) (Quintals)
0
1 5 3 : | Stage] oweasing
2 2 6 7 * retums
4 2 $ 5 } Stage I Diminishing
5 20 4 0
§ | oH | 23 f smem ere It B.Com (Semester - Il) Principle of Economics 103
Inthe beginning by increasing the units of variable factor i.e.,
labour the total product increases at an increasing rate. For example,
the output produced by one labourer is five quintals and the output
produced by two labourers is 12 quintals which is more than double.
Thus when the total product increases at an increasing rate, the
average product and marginal product also increases. This is the
“first stage’ which is known as the stage of “Increasing returns’.
As more number of labourers are employed further the total
product increases at a diminishing rate and becomes maximum at
the fifth labour. Therefore, the average product and marginal product
start decreasing. The marginal product becomes zero at the fifth
labour. This is the ‘Second Stage’ which is known as the state of
“Decreasing Returns’.
Ifthe cultivator will continues to employ more labourers, the
average product further falls and the marginal product becomes
negative. The total product is diminishing. This is the “Third stage’,
which is known as the ‘stage of negative returns’.
The law of variable proportions can be explained with the
help of the following diagram.
25 4
Total B
product 20 | A
'
Average 15 4
product i
10 4
Marginal |
product 5 ;
TP
0 | N WN
69 1234656
Variable Factor
MP
In the above diagram the variable factor i.c., labour is shown
on X-axis and the output is shown on Y-axis. Up to ON Labourers
(Le, 3 labourers). The total product increases at an increasing rate. Producer Equilibrium 104
The marginal product curve reaches maximum at point Q, and then
starts falling, the marginal product curve cuts the average product
curve at the latter maximum point Q. At this point average product
= marginal product. Thisis the first stage ‘Increasing Returns’ take
place.
When the number of labourers is more than ON the total
product curve increases at a diminishing rate. While average product
curveand marginal product fall. At ON, Labourers, the total product
curve reaches the maximum at point B and marginal product curve
intersects the X-axis. This is the second stage in which ‘Diminishing
Returns’ take place.
The third stage refers to negative marginal returns. Beyond
ON, labourers TP Curve also falls, MP Curve enters the negative
quadrant. The average product continues to fall. This is the third
stage in which “Negative Returns’ take place.
The third stage refers to negative marginal returns. Beyond
ON, labourers TP curve also falls, MP curve enters the negative
quadrant. The average product continues to fall. This is the third
stage in which “Negative Returns’ take place.
In the above three stages, the important stage is the second
stage. In the first stage output increases at an increasing rate. Any
rational producer cannot stop at this stage. Similarly, the producer
will not carry production in the third stage as it gives negative returns.
Therefore, a rational producer will neither stop in the first stage nor
enter the third stage. The second stage indicates the economic region
to the producer.
6. Explain the law of Returns to Scale with a suitable
diagram.
(Or)
Write about the Longrun Production function.
Ans : The law of variable proportions is applicable in short periods.
Inthe short period some factors remain fixed and it is not possible to
vary their amount, output can be increased by varying other factors. It B.Com (Semester - Il) Principle of Economics 105
In the long run all factors including plants and machines are
variable. A firm can expand its scale of operations longrun. It means
that the firm expands production by increasing all inputs i.c., more
equipment, more labour, more space etc. Ifthe increase in output is
proportional to the increase in the quantities of the inputs, the returns
to scale are said to be constant. Here, a doubling of factors or inputs
causes doubling of output. Ifthe increase in output is more than
proportional, the returns to scale are increasing. If the increase in
output is less than proportional, the returns to scale are decreasing.
When a firm expands its scale, it first passes through a phase
of increasing returns to scale, then a phase of constant returns, and
finally a phase of diminishing returns to scale.
Assumptions : The law however, assumes that :
1. Techniques of production is unchanged.
2. Allunits of factors are homogencous.
3. Returns are measures in physical terms
4. The law operates in the long - run.
There are three phases of return in the long run which may be
separately described as:
A) The law of increasing returns
B) The law of constant returns
C) The law of decreasing returns.
Let us briefly describe these laws.
a) The law of Increasing returns : The law of increasing
returns describes increasing returns to scale. There are increasing
returns to scale when a given percentage increase in output will lead
toa greater relative percentage increase in the resultant input.
Algebrically,
AP
Where, > = Proportionate change in output.
-* Proportionate changes in inputs (factors) Producer Equilibrium 106
Increasing return to scale arise due to the following reasons.
i) Indivisibility of Factors : Increasing returns to scale arise
due to the individualities of some factors of production. Since a
machine is indivisible, its full capacity has tobe utilized in the process
of production. For example, suppose a machine has the capacity to
produce 1000 pens a day. If the machine produces 200 pens per
day. The fixed cost of machine will be distributed over 200 pens.
On the other hand ifit uses its full capacity i.e., produces 1000 pens
a day the fixed cost (machine cost) will be spread on 1000 pens
which reduces the per unit cost of production drastically. Thus,
increasing returns arise due to the indivisibility of the machine. This
indivisibility applies to labour also.
ii) Dimensional Relations : Increasing returns arise with
the increase in dimensions. It is cheaper to construct bigger machines.
It is also cheaper to operate them. For example, the cost of
construction of double decker bus is not double to that of an ordinary
bus. Its operations costs are also not double. But it can carry double
the number of passengers. Thus with an increase in dimensions,
advantages will arise. Ifthe diameter ofa water pipe is doubled, the
flow of water through the pipe will be more.
iii) Specialization : (Division of labour) : Increasing
returns occur due to specialization also. When the units ofa variable
factor are increased there is a greater cooperation and higher degree
of specialization. When the size of a firm increase, it leads to
specialization of labour & capital which in turn leads to increasing
returns to scale. Specialization leads to internal and external
economies.
B) Constant Returns to scale : The process of increasing
returns to scale, however, cannot go on forever. It may be followed
by constant returns to scale. As the firm continues to expand its
scale of operations, it gradually exhausts the economies responsible
forthe increasing returns. Then the constant returns may occur. There
are constant returns to scale when a given percentage increase in
inputs leads to the same percentage increase in output. It B.Com (Semester - Il) Principle of Economics 107
AP AF
Algebrically, 7 = -
©) Decreasing returns to scale : As the firm expands, it
may encounter growing discconomies of the factors employed. As
such when powerful diseconomies are met by feeble economies of
certain factors, decreasing returns to scale set in . There are decreasing
returns to scale when the percentage increase in output is less than
the percentage increase in input.
Algebricall a < Ar
BeOnicaly, “pe
When the scale is increased too much, the problem of
supervision and co-ordination becomes difficult. Thus a firm first
gets increasing return to scale then constant returns to scale and
ultimately decreasing returns. Retums to scale can be explained with
the help of the diagram.
Y|
Marginal Returns
Xx
O Scale of Production
In the above diagram, Scale of production shown on X-axis,
and marginal returns are shown on Y-axis. RCDS is the returns to
scale curve, where from R to C the returns are increasing, from C
To D they are constant and from D to S they are diminishing. Producer Equilibrium 108
7. What is meat by Economics of Scale ? What are its
types ? (Or)
Explain the advantages of large Scale Production.
(Or)
Write about internal Economies and External
Economies.
Ans : Economies of scale : One of the important factors which
determine the volume of production is the scale of production adopted
by firms. When a firm produces on large scale by expanding its size
it can introduce new types of machinery and new methods of
organization which will lead to improvements in efficiency of
production. When a firm is small it cannot use expensive machinery.
The advantages that acquire a firm as a result of increase in its scale
or growth in its size are called economics of scale. Such economies
of scale have been classified by Marshall into External and Internal
economies.
Internal Economies : Internal economies are those
economics which are open to an individual firm when its size expands.
They emerge with in the firm itself as its scale of production increase.
Internal economies in the scale of its output cannot be realized unless
the firm increases its input, i.c., expands its size. Thus, internal
economies are the function of the size of firm. Internal economies
are classified into five types — technical, managerial, commercial,
financial and risk spreading.
i) Technical Economies : Technical economies are those
which arise from the use of better machines and techniques of
production. Asa result of these economies, there will be an increase
in the production and fall in the cost of production per unit.
ii) Marketing Economies : A large firm purchases various
inputs in bulk and therefore, it can secure them at cheaper rate when
compared to the small firms. It can also secure special transport
concessions, better quality inputs etc. It can sell its finished goods
without any difficulty. It can also have its own sales agency and
marketing department. Thus, as the scale of the firm increases, it
obtain the economies of purchase & sale. It B.Com (Semester - Il) Principle of Economics 109
iii) Managerial Economies : Managerial economies arise
due to a better and more elaborate management which only the large
size firm can afford. A large firm can appoint specially qualified and
highly paid officials to look after the production, accounts,
advertisement etc. Thus, with the increasing scale of output greater
managerial economies are enjoyed by an expanding firm.
iv) Financial Economies : A large sized firm can reduce its
costs of borrowing from the banks and other financial institutions. It
can procure finance in time at cheaper rates of interests because it
possesses large assets and good reputation. It can also mobile fresh
capital by floating shares and debentures in the capital market easily.
v) Risk bearing Economies : A large firm can produce a
number of products in different varieties and sell them in different
areas. Therefore, it is in a better position than a small firm in facing its
risks. It can counter balance the loss in one product by the gain the
other products.
External Economies : When the number of firms producing
the same commodity increase in a particular areas, all the firms enjoy
certain advantages which are called external economies.
External economies arise because of the following reasons.
Economies of concentration : Concentration of a particular
industry in one area results in the development of conditions helpful
to the industry. When the firms in an industry are established at the
same place, they all can get some common benefits like provision of
better transport, facilitics, availability of skilled labour, better financing
facilities, better power resources, better research facilities, etc. The
cost of production is there by reduces.
Economies of Information : When many firms are located
at one place, they enjoy economies of information. They can
collectively publish trade and technical journals. The industry can
also set up an information centre. When the firms in the industry
increased in number, all the firm get the information regarding price
ete. Producer Equilibrium 110
Economies of specialization : When a number of firms are
concentrated in a particular area, they can specialize in different
processes, so that, the industry benefits as a whole. For example,
when the cotton textile industry expands, some firms can specizlie in
manufacturing thread, some others in weaving and some others in
printing and so on. Asa result, the productive efficiency of the firms
specializing and so on. Asa result, the productive efficiency of the
firm specializing in different fields increases and the cost of production.
falls.
Economies of Welfare : When many firms are located in a
particular area, the industry is in more advantageous position to
provide welfare facilities to the workers. It can set up housing colonies
tothe workers. It can provide public health and recreational facilities
and also establish educational institutions etc. Such facilities increase
the efficiency of the workers who work for the quality and quantity
of the products of the industry.
Thus, both internal and external economies increases the output
and reduce the cost of production. But, these economies arise only
uptoa particular limit beyond which diseconomies emerge.
( 8 Discuss the properties of Isoquants.
Ans: An Iso-product curve shows different combinations of factors
of production which yield equal production. Since all combinations
on the same Iso-product curve give the producer the same amount
of production, he is indifferent to these combinations. That is why
Iso-product curves are sometimes called “Production indifference
curves’.
Properties of Iso-product curves or Isoquants: Iso-
product curves have almost the same properties as are possessed
by the indifference curves. Some important properties of the iso-
product curves are as follows :
i) Iso-Product Curves Slope Downward from Left to
Right: An iso-product curve is falling downward from left to right.
This can be explained with the help of the concept of marginal rate
of falling technical substitution. We know that points on iso-product It B.Com (Semester - Il) Principle of Economics 111
curveyield the same amount of output when we increase the amount
of one factor of production, the amount of the other factor of
production has to be decreased. It is a must for keeping the level of
output constant. If we increase the amount of one factor without
decreasing the amount of the factors, output will increase. The
downward sloping nature of the iso-product curve can be explained
with the help ofa figure.
Yh
a
Units of Capital
kK
Z :
Oo
L Ty x
Units of Labour
The diagram shows that when the amount of labour is increased
from OL to OL,, the amount of capital has to be decreased from
OK to OK,. This is a must for keeping the level of output constant.
When we join these input combinations, we get an IQ curve falling
downward from left to right.
The possibilities of horizontal, vertical, or upward sloping iso-
product curves can be ruled out. This we can prove with the help of
the diagrams. The first figure shows that as amounts of both factors
of production i.e., labour and capital are increased, output also
increases and that is why IQ slopes upward. This is not possible
since the basic property of IQ is disturbed i.e all combinations on
the same IQ yield equal amounts of output does not seem to be true.
Similarly in figures (ii) and (iii) amount of one factor is increased
while keeping constant the amount of other factor. This also gives
the same level of outputs as we move from combination A to B. And
itis against the given assumption. In other words IQ slopes downward
from left to right. Producer Equilibrium 112
Yt Ya vs
ia
ia _
z
z Bg a
BK & K B &
8) é° Sk AB ig
SK 3k aA 2
2 2 5
5 5
- ~ ~X
Lo x ° cx O° chy
Units of Labour Units of Labour Units of Labour
@ @ @
ii) Iso-Product curves are Convex to the Origin: This
property of IQ can be explained with the help of the concept of
MRTS. As we know from our earlier discussion, MRTS has a
diminishing tendency. In other words, when we go on increasing the
amount of one factor of production by reducing the amount of other
factors of production, we see that less units of capital are sacrificed
for the additional units of labour. This property of IQ gives the IQ a
convex shape. Ifthe IQ were concave as shown in the figure, MRTS
would increase thereby showing that more units of capital would be
sacrificed for getting more units of labour. But it is against the given
assumption that MRTS is always diminishing. Therefore, an Iso-
product curve is always convex to the origin.
Yh
wr AB=BC=CD.
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