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Meaning of production
Important economic activity Performance of economy is judged by the level of its production
In Economics
A process by which man utilizes or converts the resources ofnature, working upon them so as to make them satisfy humanwants.
Any economic activity which is directed to the satisfaction of thewants of the people.
Therefore, manufacture of goods or rendering services are alsotermed as production.
E.g. water made drinkable, cotton made wearable, retailers,doctors, lawyers.
Production can also be defined as creation or addition ofutility – Not creation of matter
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The satisfying power of goods & services is called
utility.
Utilities can be created in different ways
A) Form utility– log into wood, iron into machine
B) Place utility – oil from Malaysia, apples
C) Time utility – preservation/storage
D) Possession utility – flat/house/office
E) Service utility – teachers/singers/musicians
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The relationship between the inputs and outputs of a
firm is referred as production function Also defined as the minimum quantities of various
inputs that are required to yield a given quantity ofoutput
Outputs– volume of goods or services
Inputs – factors of production
PF can be studied in short term or long term basis
Short period – too short for the firm to make changes
in equipments and therefore capital employed remainsfixed – Law of variable Proportion
Long period – all the factors of production are variable– Law of returns to scale
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A firm must decide how much to produce
Increase in scale of productions means increase in
output
Economies of large scale production– Advantages of
producing more.
Classified in to Internal and External economies of
scale
Internal Economies–Benefits observed within the
firm and its department
External Economies – Benefits observed as a result in
expansion of Industry as a whole.
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Technical economies
Economies of increased dimensions
Economies of linking of processes
Economies of Superior Technique Economies of specialization and Division of Labour
Managerial &Commercial Economies
Marketing Economies
Financial Economies
Risk-Bearing Economies
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Supervision & Management becomes difficult
Obstruction to work like Strike, Lockout, Disputes
increases
Product are standardized and thus personal touchwith consumer is many a times not possible
May cause overproduction and results into losses
Fight hard to maintain the market
Not flexible
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Encouraging competition
Over crowding of cities, traffic congestion,
pollution
Strain on whole Industrial System
Highlighted in the eyes of government & tax
department
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Land: refers to all free gifts of nature which would includebesides land, the natural resources.
Labor: mental or physical exertion directed to produce goods or services.
Anything done out of love & affection does not represent labor ineconomics.
E.g. wife & maid, singing
Capital: part of wealth of an Individual or community which is used for
further production of wealth
Produced means of production
E.g. machines, tools, dams, transport equipment.
Entrepreneur: is a factor which mobilizes above factors,combines in the right proportion, then initiates theproduction and bears the risk involved in it.
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Statement of the law:
“The law of variable proportions states that when more and more
units of the variable factor are added to a given quantity of fixed
factors, the total product may initially increase at an increasing rate reach the maximum and then decline”.
Assumptions
1. The law applies only in the short run.
2. One factor of production is variable & others are fixed.
3. All units of variable factor are homogeneous.
4. State of technology is given & remains the same.
5. Factor proportions can he changed.
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Key terms in production analysis
Total product (TP): The total amount of output
resulting from the efforts of given production function
at a given time
Average product(AP): Total product per unit of giveninput factor.
Marginal product(MP): The change in total product per
unit change in given input factor or the quantity ofvariable factor.
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Three Stages of Production in Short
RunAP,MP
X
Stage IStage II
Stage III
APX
MPXFixed input grosslyunderutilized;
specialization andteamwork causeAP to increasewhen additional Xis used
Specialization andteamwork continue to
result in greateroutput whenadditional X is used;fixed input beingproperly utilized
Fixed input capacityis reached;additional X causesoutput to fall
THE LAW OF DIMINISHING RETURNS &
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-2
-1
0
1
2
3
4
5
0 1 2 3 4 5 6 7
0
2
4
6
8
10
12
14
16
1 2 3 4 5 6 7 6
’
Total
Product
Marginal
&
Average
Product
Labor
Labor
THE LAW OF DIMINISHING RETURNS &
ST GES OF PRODUCTION
Stage I Stage II Stage III
TP
MP
AP
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Three stages of production
-Stage I: Increasing Returns –
TP increases atincreasing rate, indicated by increasing MP.
-There is intermediary constant stage between
stage I & stage II. TP increases at a constant rate
indicated by constant MP
-Stage II: Diminishing Returns – TP continues to
increase but at diminishing rates, indicated by
declining MP
-Stage III: Negative Returns – TP begins to decline,
indicated by negative MP
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1. When TP increases at increasing rate, MP also increases. 2. When TP starts increasing at decreasing rate, MP
decreases but remains positive 3. When TP is maximum & constant MP is O (zero) 4. When TP begins to fall, MP is negative• If MP is positive then TP is increasing.
• If MP is negative then TP is decreasing.
• TP reaches a maximum when MP=0 (MaximizationCondition!)
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Marginal and Average Product
When marginal product is greater than the average product,
the average product is increasing
When marginal product is less than the average product, the
average product is decreasing
When marginal product is zero, total product (output) is at
its maximum Marginal product crosses average product at its maximum
▫ If MP > AP then AP is rising.
▫
If MP < AP then AP is falling.
▫ MP=AP when AP is maximum
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Three stages of production
Total Product Marginal Product Average Product
STAGE I
Increases at an increasing
rate
Increases and reaches its
maximum
Increases (but slower than
MP)
STAGE II
Increases at a diminishing
rate and becomes
maximum
Starts diminishing and
becomes equal to zero
Starts diminishing
STAGE III
Reaches its maximum,
becomes constant and
then starts declining
Keeps on declining and
becomes negative
Continues to diminish
(but must always be
greater than zero)
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1. Increasing return to a factor:-
(i) Fuller utilization of fixed factor : In the initialstages Fixed factor remain under utilized its fuller
utilization starts with the more application of
variable factor, hence, initially additional unit of
variable factors add more to the total output
(ii) Specialization of Labour :- Additionalapplication of Variable factor causes process based
division of Labour that raises the efficiency offactors. Accordingly marginal productivity tends to
rise.
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2. Diminishing return to a factor:-
(i) Imperfect factor substitutability :- Factors of
production are imperfect substitutes of each other.More & more of Labour, for eg. Cannot be
continuously used in place of additional capital.
Accordingly diminishing returns to variable factor
becomes inevitable.
(ii) Disturbing the optimum proportion :-
Continuous increase in application of variable factor
along with fixed factors beyond a point crosses the
limit of ideal factor ratio. This results
in poor co-ordination between the fixed & variable
factors which causes diminishing return to a factor.
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3. Negative returns to a factor :-
(i) Overcrowding :- When more & more variable
factors are added to a given quantity of fixed
factor it will lead to over crowding & due to
this MP of the Labours decreases & it goes into
negative
(ii) Management Problems :- When there are toomany workers they may shift the responsibility to
others & it becomes difficult for the managementto coordinate with them. The Labours avoid doing
work. All these things lead to decrease in
efficiency of Laboures. Thus the output also
decreases.
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Production should be stopped at the point where
Marginal Product is equal to Marginal Cost
Here there is maximum utilization of resources
MP=MC= max utilization of resources.
Ideally it should beMP ≥ MC
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Production Function in Long Run
Laws of Returns to Scale
The percentage increase in output when all inputs vary
in the same proportion is known as returns to scale. It
obviously relates to greater use of inputs maintaining
the same technique of production.
Three Situations of Returns To Scale
- Increasing Returns to Scale - Constant Returns to Scale
- Decreasing Returns to Scale
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This law states that with
an increase in the quantity
of variable factor, average
and marginal productsshow a tendency to rise
(i.e. total product increases
with an increasing rate)
No
of
men
Total
Product
Average
Product
Marginal
Product
0 0 0 0
1 20 20 20
2 50 25 303 90 30 40
4 160 40 70
5 250 50 90
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This law explains that if the
quantity of a variable factor
is changed then the average
and marginal products will
not change i.e. total outputwill increase only at a
constant rate
This law is the intermediate
stage between the initialstage of the increasing return
and the ultimate stage of the
diminishing returns.
No
of
men
Total
Product
Average
Product
Marginal
Product
0 0 0 --1 100 100 100
2 200 100 100
3 300 100 100
4 400 100 100
5 500 100 100
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It is the ultimate stage of
production.
Initially an increase in the
quantity of variable factors
results in higher efficiency
and more production.
But beyond the optimum
stage increase in the variable
factors only disrupts the
existing organization andleads to inefficiency.
At this stage the average and
marginal products
continuously fall.
No
of
men
Total
Product
Average
Product
Marginal
Product
0 0 0 01 10 10 10
2 18 9 8
3 25 8.3 74 30 7.5 5
5 32 5.4 2
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Returns to Scale
Increasing returns to scale: output
more than doubles when all inputs are
doubled
Larger output associated with lower cost
(cars)
One firm is more efficient than many
(utilities)
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Higher degree of specializationCertain inputs cannot be divided into parts to suit small scaleproduction.
Technical and managerial indivisibilities
Use of specialized labour and modern machineryincreases productivity for variety of inputs.
Dimensional relations
Length and Breadth
15*10=150 sqft
30*20=600 sqft
The causes of increasing returns to
scale:
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Returns to Scale
Constant returns to scale: output
doubles when all inputs are doubled
Size does not affect productivity May have a large number of producers
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Returns to Scale
Decreasing returns to scale: output
less than doubles when all inputs are
doubled
Decreasing efficiency with large size
Reduction of entrepreneurial abilities
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Supply & Law of supply The concept supply occupies a signif icant place in economic
theory. Supply analysis is related to the behaviour of the producer –
supply of a commodity influenced by price of commodity.
In the ordinary language supply mean the stock of goods inexistence .
It is also mean the amount of good offered for sale per unit oftime .
In economics, supply mean during a given period of timequantities of goods which are offered for sale at particularprices.
Thus, supply of a commodity may be defined as the amount of thecommodity which the sellers are able & wil l ing to offer for sale ata particular period a given period of time .
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Thus, supply is always at a price & in relation to a period of time.
The higher the price, the greater will be the quantityof a commodity that will be supplied by a producer &vice – versa.
Therefore, the relationship between price & quantitysupplied is direct and positive.
Factors influences supply The quantity supplied of a commodity is not
dependent upon its price alone but on a number offactors such as –
Price of other commodities The prices of factors used in its production
The goal of producers &
The state of technology
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These factors can be written in the form of an
equation known as the supply function
(supply function)
Sq = f (pq, Pa, Pb…..F1, F2 … G, T)
Sq = Supply of commodity q
f = Functional relationship betweenprice of commodity & quantity supply
Pq = Price of commodity q
Pa Pb = Prices of other commodities
F1 , F2 = Prices of factors of production
G = Goal of producers
T = State of technology
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1. Price of the commodity
higher the price of commodity the larger
will be the quantity supplied and vice-versa.2. Prices of other commodities
A change in the price of other commodity
also affects the supply of commodity
For instance, if the price of good A rises, the
producer of good B may produce less of
good B & switch over to the production ofgood A in order to sell more of it.
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3. Price of factors
If the price of any one factor of production (labour &capital) used in the production of a commodity increases, it
cost of production will increase. As a result, its output will falls & the supply will be
reduced.
The reverse will happened in the case of fall in the price ofa factor.
4. Goals of Producers
If a producer aims at maximising profit, he will produceless of the commodity which involves large risk.
A producer who aims at maximising his sales will produce
& sell more.
5. State of Technology
If new & improved methods of production are used, theytend to increase the supply of commodities.
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The Law of Supply
Supply of a commodity is functionally related to its
price. The law of supply relates to this functional
relationship between price of a commodity & its
supply.
That is, higher the price, higher will be quantitysupplied & lower the prices lower will be quantity
supplied.
The law of supply can be stated that“other
thingsremaining the same, as the price of a commodity
rises, its supply is extended and as the price falls,
its supply is contracted.
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The quantity offered for sale directly varies withprice – higher the price, larger is the supply and
vice-versa.Supply Schedule
Supply schedule is a statement of variousquantities of given commodity offered for sale at
various per unit of time. A supply schedule may be individual supply
schedule or market supply schedule.
Individual supply schedule is a list of prices &
quantities that an individual is willing to produce& sell.
Whereas the market supply schedule is thesum total of individual supply schedules.
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Supply Schedule
Individual Supply
Schedule
Market Supply
Schedule
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Individual Supply Schedule
Prices (per dozen) in Rs Quantities of supplied
4 300
6 4008 500
10 600
12 700
14 900
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S
S
Quantities of Supplied
P r i c e s
300 600 900 1,200
8
6
4
2
B X
Y
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Market Supply Schedule of Product
Price ( inRs.)
Commodity is identical Aggregate
of A, B,and CA Firm B Firm C Firm
2 000 000 000 000
4 300 400 50 750
6 400 200 200 900
8 500 400 300 1200
10 600 500 400 1500
12 700 600 500 1800
14 900 800 750 2450
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Assumptions of the Law of the Supply
The number of firms in the market remains the same.
The scale of production do not change. Market prices of related goods remains constant over a
period of time.
Cost of Production does not change. Climatic conditions remains constant.
Taste and preferences of consumers remains constant.
Government polices such as taxation policy, trade
policy should be unchanged.
No changes in transport costs
No. other inputs are available in the market.
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Feature of the Law of Supply
1. There is a direct relationship between
quantity supplied and price.2. There are two variables – price and supply –
supply is the dependent variable and price
is an independent variable.3. This law is not universal in nature – it is
based on certain assumptions – other things
remaining constant.
4. Supply curve usually slopes upward from
left to r ight.
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Factors DeterminingSupply
Price TimePrices of related
commodities
Cost ofProduction Technology
NaturalFactors
Govt Policy & Action
FutureExpectations
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1. Price of the commodity
Higher the price of a commodity larger will be
the quantity supply and vice – versa. Higher prices always brings profit to producers.
2. Prices of related commodities
A change in the price of another commodity alsoaffects the supply of a commodity.
For instance, if the price of good A rises, the
producer of good B may produce less of good B
and switch over to the production of good A inorder to sell more to make an profit.
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3. Prices of factors of production
If price of factors of production increases – (labour
and capital) – cost of production increases andoutput will decline.
The reverse will happen in the case of a fall in the price of a factor.
4. Goal of Producers If a producer aims at maximising profit, he will
produces less of commodity and will involve largerisks.
A producer who aims at maximizing his sales will produce and sell more.
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5. State of Technology
If new and improved methods of production are
used – they tend to increase the supply ofcommodities.
6. Number of firms and sellers existence
Supply in a market depends on the no. of
firms/sellers producing and selling in the market.
When producer/sellers are few – supply will be
small and vice – versa.
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7. Cost of Production
The cost of production is an important item
affecting the supply. Wages, rate of interest, price of machinery
and equipment, raw-material etc influenceson cost of production.
8. Future Expectation
Seller sells the commodity or supplies on the basisof the prevailing prices.
If he feels that future prices will be higher, he willreduce the present supply of the product.
If he feels that future prices may fall he will betempted to sell more at the current prices.
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9. Natural factors
It is assumed that there is no change in natural factors
such as rain, drought etc – Agro Industries. Monsoon failure may result in the reducing of power
generation and eventually lead to curtailment of production.
10. Change in Government Policy Any change in govt policy will affect the supply.
A fresh tax or levy of excise duties on commoditywill affect the price of the commodity and as a resultthe supply will get affected.
An increase in tax will reduce the supply and grantingof subsidy and incentive will increase the supply.
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Elasticity of Supply
Supply change due to change in price
The extent of change in supply in accordance
with the change in price is called elasticity of
supply.
When, with a little change in price (rise/fall)
there is a considerable change in supply
(rise/fall).
The elasticity of supply is the degree of
responsiveness of a change in supply to a
change in price on the part of sellers.
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Elasticity of Supply
Es = Percentage Change in Quantity Supply
Percentage Change in Price
=Change in Quantity Supply
Change in price Initially
÷Change in Price
Initial supply
=∆Qs
Qs*∆P
P
Where
∆Qs = Change in Quantity Supply
∆P = Change in Price
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Types of Elasticity of Supply
1. Perfectly elastic supply
2. Perfectly inelastic supply
3. Unitary elastic supply
4. Relatively more elastic supply
5. Relatively less elastic supply
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1. Perfectly elastic supply When a small change in price lead to an infinitely large change
in the quantity supplied. Es =∞
Quantities of Supplied
P r i c e
P
O X
Y
SS
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2. Perfectly inelastic supply
When a change in price causes no change in
supply whatsoever. Es = 0
S
S
O X
Y
P
P1
P2
M
P
r i c e
Quantity of Supplied
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3. Unit elasticity of supply
The change in quantity of supply is exactly equal to
the change in price. When both are equal the elasticity is said to be
unitary. Es = 1
P r i c e s
Quantity of supply
P
P1
M M1O X
Y
S
S
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4. Relatively more elastic supply
It refers to that situation where a proportionate change in the
quantity of supply is much greater than the proportionate
change in price.
In other words, it refers to that situation where a small
proportionate fall in price of a commodities is followed by a
large proportionate increase in its quantity supply and vice
versa. Es > 1.
S
S
P
P1
O
Y
X
Quantity Supply
M M1
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5. Relatively less elastic Supply
It refers to that situation where the proportionate change in the
quantity of supply is much less than the proportionate change
in price.
In other words, it refers to that situation where a great
proportionate fall in price of a commodities followed by a
small proportionate changes in quantity supply.
Es < 1.
P
P1
M M1
Y
XO
S
S
P r i c e
Quantity Supply
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Table - Types of Price Elasticity of Supply
Sl No. Types of
ES
Numerical
Expression
Description Shape of
Curves
1. Perfectly
Elastic
∞ Infinite Horizontal
2. PerfectlyInelastic
0 Zero Vertical
3. Unit Elastic 1 One Rectangular
Hyperbola
4. RelativelyElastic
> 1 More thanOne
Flat
5. Relatively
Inelastic
< 1 Less than
One
Steep
T f El i i f S l
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Types of Elasticity of Supply
S1
S2
S3
S4
S5
S
Quantity of Supply
Price
S5 = 0
S1 = < 1
S3 = 1
S2
= > 1
S4 = ∞
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