Unit 5 Business Economics

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    Unit-5

    Theory of

    Production

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    Syllabus content

    Rent: Concepts of Differential Rent and Scarcity Rent,Economic and Contract Rent, Quasi Rent and Pure Rent

    Wages: Concepts of Time Wages, Piece Wages, andMoney wages, real Wages and factors determining realWages.

    Production: Meaning and Concept of Production,Factors of Production and Production function, Fixedand Variable Factors, Law of Variable Proportion (ShortRun Production Analysis), Law of Returns to a Scale(Long Run Production Analysis) through the use of ISOQUANTS.

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    Some Basic Concepts

    1. Production: It is a process where inputs areconverted into output.

    2. Input : It is anything which is used to producegoods or service.

    3. Output: It is final goods or services producedafter process on input

    4. Fixed Factors: The supply of the factors is

    constant in short run. Those factors are called asfixed factors

    5. Variable Factors: The supply of the factorschanges in long run. Those factors are called asvariable factors.

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    Factors of Production

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    What Is Production Function ?

    The relationship between the inputs and the

    resulting output is described as production

    function in Economics.

    A production function shows the relationship

    between the amounts of factors used and the

    amount of output generated per period of

    time.

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    Production Function

    For convenience production function is

    written as follows

    X=f (L,K)

    Here L= Labour

    K= Capital

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    Production Function

    Short term: Time when one input (say, capital)

    remains constant and an addition to output

    can be obtained only by using more labour.

    Long run: Both inputs become variable.

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    Law of Variable Proportions

    Law of Variable Proportions (Short run Law ofProduction)

    Assumptions:

    One factor (say, L) is variable and the other factor(say, K) is constant

    Labour is homogeneous

    Technology remains constant Input prices are constant in the time under

    consideration

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    Law of Variable Proportions

    No of Workers

    L

    Total Product

    (TPl)Marginal

    Product (MPl)Average

    Product (APl)Stages ofReturns

    1 24 24 24 I)

    Increasing

    Returns2 72 48 36

    3 138 66 46

    4 216 78 54

    5 300 84 60

    6 384 84 64

    7 462 78 66 II)

    DiminishingReturns8 528 66 669 576 48 64

    10 600 24 60

    11 594 -6 54 III) Negative

    Returns12 552 -42 46

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    Law of Variable Proportions

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    Law of Returns to a Scale

    Also called as production function in long run

    X=f (L,K)

    In long run L and K are variable

    This law shows various combinations of L and K

    The graph is called as isoquants

    Assumptions:

    There are only two factors of production

    Technology does not change

    Continuity in production

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    Isoquant Map

    More than one isoquants depicted in onegraph is called isoquant map

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    Characteristics of Isoquants

    Isoquant slope downward to the right

    Isoquant are always convex to the origin

    Isoquant can never intersect each other

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    Differential Rent And Scarcity rent

    Differential Rent means that the investor who

    produces wheat on the more productive lands

    reaps an extra-profit or rent on that land.

    Scarcity rent is the cost of "using up" a finite

    resource because benefits of the extracted

    resource are unavailable to future

    generations.

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    Economic and Contract Rent

    Economic rentis the difference between what

    an owner of a factor of production (such as

    land, capital or labor) receives and the

    opportunity cost for that owner.

    Contract Rent is the amount of total

    contractual payment made by the tenant to

    the landlord according to the agreement

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    Quasi Rent and Pure Rent

    Quasi rent means when one makesan investment and pays for it, and then earnsincome from it without needing to make further

    investment. Pure Rent means income received from the use

    of a resource whose supply, in the long run, istotally unresponsive to its price because it can

    neither be produced nor destroyed byits consumers.

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    Wages

    The Wage = "price of labor

    Time Wages: The wages paid according to the

    hours of working.

    Piece Wages: The wages paid according to

    number of products produced.

    Money Wages: The wages received in terms of

    money.

    Real Wages: The wages with real value.

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    Factors determining Real Wages

    Price level:Money wage remaining constant, Real wage = Money Wagedivided by Price level. Higher the price level, lower will bethe real wage and vice versa.

    Money wages:If the price level remains constant and the money wagesincrease then real wage also increases. But if the rise inprice level is higher than the rise in money income, thenthe real income would fall.

    Fringe benefits:Cash-in-kind or fringe benefits or perks like freeaccommodation facilities, free transport, medicalreimbursement, subsidized food from canteen etc. increasethe real wage of a worker.

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    Factors determining Real Wages

    Nature of job:In a risky and dangerous jobs, money wage may behigher but real wages are low. For example workers inmines. The real wage of workers in a regular job is

    higher than those in an irregular job. Scope for extra earnings:

    In jobs where there is a possibility of extra earnings thereal wage would be high.

    Future prospects:

    In jobs if future prospects like quick promotion andhigher earnings are possible then the real wage wouldbe high.