NAME ARFA AREEJ
ROLL NO L1F24LLBH0021
SECTION LLB(A)
SUBJECT NAME Fundamentals of Economics
PROF NAME Dr Ghulam Saghir
ASSIGNMENT NO #2
Theory of Production and Demand
Production and demand theories are vital parts in understanding how markets function,
allocate resources, and determine prices; while looking into them in more focused detail
now.
Theory of Production
Production Theory refers to the processes through which inputs are converted into outputs. It deals
with the ways in which businesses convert resources such as labour, capital, and raw materials into
goods or services.
Functions:
Production Function: A production function is the association between the amount of inputs utilized
and the total amount of outputs obtained. It is generally written like this:
Q=f(L, K)Q = f(L, K)
where Q is the output, L is labour, and K is capital.
Cost Function: This reflects the cost incurred to produce different levels of output,
given the input prices. It is usually expressed as:
C=f(Q)C = f(Q)
where C is the total cost and Q is the output.
Marginal Product: The additional output produced by using one more unit of a
particular input, holding other inputs constant.
2. Theory of Demand
this is the theory which discussed how a consumer has to go for the decision of purchase of
goods and services. This theory mainly refers to the price of goods and the quantity
demanded.
Demand Function: It gives the key contents related to demand function-the demand
function states how the quantity demanded of a good is related to the price of that
good among other factors such as income and tastes. It may be expressed in terms of
the demand functions as follows:
Qd=f(P,I,T)Q_d = f(P, I, T)
where Q_d is the quantity demanded, P is the price, I is income, and T are tastes/preferences.
Price Elasticity of Demand: It measures the responsiveness of the quantity
demanded to change in the price. The formula on how to compute it is given as:
ϵ=% change in quantity demanded/% change in price
Relation Between Production and Demand
That's how a production-demand relationship can produce market equilibrium.
Market Equilibrium: The point where the quantity offered by producers meets the quantity
demanded by consumers at a certain price point. This point is defined by the intersection of
the supply and demand curves.
Price Determination: The market price is determined by the interplay of supply (production)
and demand. The demand increases and/or production decreases will push the prices
higher, whereas an increase in production and/or a decrease in demand drives the prices
lower.
Resource Allocation: The most efficient production and demand coordination indicates that
the resources are directed at the production of those goods and services which are most
valued by the society.
Regression Forms
Regression analysis is used to model the relationship between inputs and output in production and
between price, income, and quantity demanded in demand analysis.
Production Function Regression:
Q=α+β1L+β2K+ϵQ = \alpha + \beta_1L + \beta_2K + \epsilon
where Q is the output, α\alpha is the intercept, β1\beta_1 and β2\beta_2 are coefficients for
labour and capital, and ϵ\epsilon is the error term.
Demand Function Regression:
Qd=α+β1P+β2I+β3T+ϵQ_d = \alpha + \beta_1P + \beta_2I + \beta_3T + \epsilon
where Q_d is the quantity demanded, α\alpha is the intercept, β1\beta_1, β2\beta_2, and β3\
beta_3 are coefficients for price, income, and tastes/preferences, and ϵ\epsilon is the error
term.
EXAMPLES
1. Agricultural Production
Production Function: Analysing the relationship between the amount of fertilizer
(input) and crop yield (output). For instance, Q=10+0.5L+0.3KQ = 10 + 0.5L + 0.3K,
where LL represents labour and KK represents capital (fertilizer).
Demand Function: Examining the demand for wheat in relation to its price,
consumer income, and preferences. For example, Qd=500−2P+0.8I+1.5TQ_d = 500 -
2P + 0.8I + 1.5T, where PP is price, II is income, and TT are tastes/preferences.
2. Manufacturing Industry
Production Function: Understanding how machinery (capital) and human labor
affect the output of manufactured goods. For instance, Q=20+0.6L+0.4KQ = 20 +
0.6L + 0.4K.
Demand Function: Studying the demand for automobiles based on price, consumer
income, and market trends. For example, Qd=1000−3P+1.2I+2TQ_d = 1000 - 3P +
1.2I + 2T.
3. Technology Sector
Production Function: Evaluating the relationship between software development
hours (labour) and the number of software units produced. For instance,
Q=15+0.7L+0.2KQ = 15 + 0.7L + 0.2K.
Demand Function: Investigating the demand for a new tech gadget based on its
price, consumer disposable income, and advertising impact. For example,
Qd=800−1.5P+0.9I+0.5AQ_d = 800 - 1.5P + 0.9I + 0.5A, where AA represents
advertising efforts.
4. Food Industry
Production Function: Analysing how different quantities of raw materials (inputs)
and labour influence the production of packaged food items. For instance,
Q=30+0.8L+0.5KQ = 30 + 0.8L + 0.5K.
Demand Function: Examining the demand for a new food product based on its price,
marketing efforts, and consumer income. For example, Qd=600−2.5P+0.7I+0.8MQ_d
= 600 - 2.5P + 0.7I + 0.8M, where MM represents marketing efforts.
5. Energy Sector
Production Function: Understanding how labour and capital investments in
renewable energy sources affect electricity output. For instance, Q=40+0.9L+0.6KQ =
40 + 0.9L + 0.6K.
Demand Function: Studying the demand for electricity based on its price, population
growth, and industrial activity. For example, Qd=2000−4P+1.5G+1.2AQ_d = 2000 -
These concepts and examples illustrate how the theories of production and demand interact
and shape market dynamics, helping businesses and economists make informed decisions
4P + 1.5G + 1.2A, where GG represents population growth and AA represents
industrial activity.
