UNIT-III

2 Marks
1.Define Production Function.
A production function express the relationship between a combination of input and outputs. It is
a catalogue of output possibilities.
Q=f(a, b, c, d.n)
Where q stands for the rate of output of given commodity. (a,b.c.d.n) are different factors and
services used per unit of time. The rate of output q is thus the function in the input of factor
services, a,b,c,dn employed by the firm, per unit of time.
The Production function expresses a functional relationship between quantities of inputs and
outputs. It shows how and to what extent output changes with variations inputs during a specified
period of time.

Assumptions:
i) It is related to a particular unit of time.
ii) The technical knowledge during that period of time remains constant.
iii) The factors of production are divisible into most viable units.
iv) The producer is using the best technique available.

2. State the managerial uses of production function ?
Production function helps the managers and executives in two ways:
i) how to obtain the optimum output from a given set of inputs.
ii) How to obtain a given output from the minimum set of inputs.
iii) It helps in making long run as well as short run decisions.

3. Define ISO-Quants.
It is a technique for the study of equilibrium position of the producer is called iso-quant. It
indicates all the possible combination of two input which produce same output. Iso means equal.
Quant means quantity , Isoquant means that quantities throughout the given iso-quant are equal.
It is otherwise called as iso-product curves or equal product curves.
Combination Units of labour Units of capital
A 12 5
B 4 17
C 6 10

The table indicates that 12 units of labour and 5 units of capital, when combined as inputs, given
a product equal to 100 combination B in which 4 units of labour are combined with 17 units of
capital. Again the same 100 units of output can be had by combining 6 units of labour and 10
units of capital.









4.What is lease cost combination principle?
A rational producer as he is after maximizing profit will try to combine the factors of production
in such a way that the cost involved in the input is minimum or the least one, while the returns or
the output is the maximum.
5.What are the two laws of production
-law of variable proportion
-law of return to scale
6.Define Law of variable proportion.
In the theory of production, the law which examines the relationship between one variable factor
and output, keeping the quantities of other factor fixed is called law of variable proportions.
7. Define law of return to scale.
In return to scale, all the necessary factors of production are increased or decreased to the same
extent so that whatever the scale of production, the proportion among the factors remain the
same.
8. Define marginal cost.
Marginal cost is defined as the addition made to the total cost by the production of one additional
unit of output.
9. Define learning curve.
The learning curve shows the relationship between achievement and the number of trials or time.
Based on this, it is found that initially we incur a high unit cost and when we get experience, the
unit cost is reduced.
10. What is the rule of COBB-DOUGLAS function?
Cobb-Douglas production function relates to American manufacturing industries to labour and
capital from 1899 to 1922.
Q= K L
a
C
(1-a)


Where Q is output, L the quantity of labour and C the quantity of capital. K and a are
positive constants

The conclusion drawn from this famous statistical study is that labour contributed about 3/4
th
and
capital about 1/4
th
of the increase in the manufacturing production. The function is linear and
homogenous. It shows constant returns to scale.

11. Give the meaning of Iso-Costs line.
The combination of factors with which a firm produces the product also depends on the prices of
the factors and the amount of money which a firm wants to spend; Iso cost line represents these
two things. The prices of productive factors and the amount of money which a firm wants to
spend, Each iso cost line will show various combinations of tow factors which can be purchased
with a given amount of total money. The iso cost line is also known as price line (or) outlay line.
This can be explained with the help of a figure below:

Explanation: The slope of the iso cost line represents the ratio of the price of a unit of input X to
the price of a unit of input Y. In case the price of any one of them changes, there would be a
corresponding change in the slope of the iso cost curve and the equilibrium would shift too.

12. What are actual costs and opportunity costs ?
Actual costs which a firm incurs for producing or acquiring a product or a service. As example
for this is the cost on raw materials, labor, rent, interest. Opportunity cost refers to the value that
must be foregone in using a resource for one specific purpose or in undertaking one specific activity. .
13. What are incremental costs and sunk costs ?
Incremental cost is the additional cost due to change in the level of nature or business activity.
Sunk costs are the costs that are not altered by a change in quantity produced and cannot be
recovered.
14. What are Explicit costs and implicit costs ?
Explicit or paid out costs are those expenses which are actually paid by the firm. Implicit costs
are the theoretical costs in the sense that they go unrecognized by the accounting system.
15. What are past costs and future costs ?
Past costs are the actual costs incurred in the past are generally contained in the financial
accounts. Future costs are costs that are expected to occur in some future period or periods.
16. What are accounting costs and economic costs ?
Accounting costs are the actual outlay costs. Economic cost relate to the future outlay cost.
17. What is direct and indirect cost ?
Direct cost are traceable cost or assignable cost are the ones that have direct relationship with a
unit of operation like a product, a process or a product, or a department of the firm. On the other
hand, indirect costs or non traceable costs or common or non assignable costs are the costs
whose course cannot be easily and definitely traced to the plant.
18. What are private costs and social costs ?
Private costs are those which are actually incurred or provided for the business activity by an
individual or the business firm. Social costs on the other hand are the total costs to the society on
account of production of a good.
19. What are controllable and non controllable costs ?
Controllable costs are those which are capable of being controlled or regulated by the managers
ant = d it can be used to assess the managerial efficiency in controlling the cost in his
department. Non controllable costs are those which cannot be subjected to administrative
controls and supervision.
20. What are replacement costs and original costs ?
Original costs or the historical costs are the costs paid for assets such as land, building, cost of
plant, equipment and materials. Replacement costs are the costs that the firm incurs if it wants to
replace or acquire the same assets now.
21. What is shut down cost and abandonment cost ?
Shutdown costs are costs in which the firm incurs if it temporarily stop its operation.
Abandonment costs are the costs of retiring altogether a fixed asset from use.
22.What are incremental cost and marginal cost?
Incremental cost is important when dealing with decisions where discrete alternatives are to be
compared. Marginal cost deals with unity unit output.
23. What are the determinants of cost?
1) level of output 2) price of inputs. 3) size of plant 4) output stability
5) production lot size 6)level of capability utilization 7) technology
8) learning effect 9) breadth of product range. 10) geographical location
24. Define Cost Sheet
A cost sheet is a report on which is accumulated all of the costs associated with a product or
production job. A cost sheet is used to compile the margin earned on a product or job, and can
form the basis for the setting of prices on similar products in the future.
25. Define Nominal Cost:
Nominal Cost is the money cost of production. It is also called expenses of production. These
expenses are important from the point of view of the producer. He must make sure that the price
of the product, in the long run, covers these expenses including normal profit, otherwise he
cannot afford to carry on the business.
26. What is Marketing Diseconomies?
The expansion of a firm beyond a certain limit may also involve marketing problems. Raw
materials may not be available in sufficient quantities due to their scarcities. The demand for the
products of the firm may fall as a result of changes in tastes of the people and the firm may not
be in a position to change accordingly in the short period.

27. What is Economic Efficiency?
The production possibility curve is also used to explain the three efficiencies namely efficient
selection of the goods to be produced, efficient allocation of resources in the production of these
goods and efficient choice of methods of production, efficient allotment of the goods produced
among consumers

16 marks
1. Explain Law of variable proportion?
According to Alfred Marshall: An increase in the amount of a variable factor added to a
fixed factor causes, in the end, a less than proportionate increase in the amount of
product, given technical conditions.
Assumptions of the Law
i) The state of technology remains constant. If there is any improvement in
technology, the average and marginal output will not decrease but increase.
ii) Only one factor of input is made variable and other factors are kept constant. This
law does not apply to those cases where the factors must be in rigidly fixed
proportions.
iii) All units of the variable factor are homogeneous.
Three stages of the Law
Fixed
cost(machine)
Variable factor
(Labour)
Total
production in
units
Average
production in
units
Marginal
production in
units
1 + 1 10 10.0 10
1 + 2 22 11.0 12
1 + 3 36 12.0 14
1 + 4 52 13.0 16
1 + 5 66 13.2 14
1 + 6 76 12.6 10
1 + 7 80 11.4 4
1 + 8 82 10.2 2
1 + 9 82 9.2 0
1 + 10 78 7.8 -4


Stage I - Increasing return
In this stage, the total product increase at an increasing rate. The total product curve(TP)
increases sharply up to the point F. ie fourth combination where the marginal product MP is at
the maximum. Afterwards, ie beyond F , the total product curve increases at a diminishing rate,
as the marginal product falls, but is positive. The point F where the total product stops
increasing at an increasing rate and starts increasing at a diminishing rate is called the point of
inflection. At this point, the marginal product is at the maximum. So stage I refers to the
increasing stage where the total product, the marginal product and average product are
increasing. It is the increasing return stage.
Stage II Diminishing Returns
In the second stage, the total product continues to increase but at a diminishing rate until it
reaches the point S. where it completely stops to increase any further. At this stage , the marginal
product and average products are decling but positive. At the end of second stage, at pointS,
the total product is at the maximium and the marginal product is zero. The second stage is called
Diminishing Returns
Stage III Negative Returns
In this stage, the total product declines and therefore the TP curve slopes downwards. The
marginal product becomes negative, cutting the X axis. This stage is called negative returns.
A rational producer will produce in stage II where the total product leads to the maximum.

2.Explain the Law of Return to scale.
In return to scale, all the necessary factors of production are increased or decreased to the
same extent so that whatever the scale of production, the proportion among the factors
remains the same.

SlNo: Scale Total Product
of Corns
In units
Marginal Product
or Return in units

1 1 labour + 2 acres of Land 4 4 STAGE
I 2 2 + 4 10 6
3 3 + 6 18 8
4 4 + 8 28 10
5 5 +10 38 10 STAGE
II 6 6 +12 48 10
7 7 +14 56 8 STAGE
III 8 8 +16 62 6

From the above table, when 1 labour and 2 acres of land are employed, the total product is 4
units of corn. The input is doubled ie, 2 labour and 4 acres are employed. The output of corn is
more than double as the marginal output goes up from 4 units to 6 units. When the scale is
trebled, the total output is more than treble and the marginal output goes up from 6 units to 8
units. When the output is at 4 labour and 8 acres of land the total output reacheds 28 units and
the marginal output has reached 10 units increasing from 8 units. Upto this stage, we have
increasing return. Later on the output remains constant at 10 units. It is constant return. And the
output declines, ie the decreasing return stage.


Stage I : Increasing Return to Scale
When the increase in scale results in more than proportionate output, it is increasing return to
scale. If all inputs are increased by 20 percent and output increases by 50 percent, then the
increasing return to scale is said to be operating.
Stage II : Constant Return to scale
If we increase all factors in a given proportion and the output increases in the same proportion,
return to scale are said to be constant.
Stage III Decreasing return to scale
When output increases in a smaller proportion than the increase in all inputs, decreasing returns
to scale is said to be in operation.
3.Explain ISO QUANT in detail
ISO-QUANT OR EQUAL PRODUCT CURVE
An iso product curve also shows all possible combinations of the two inputs physically capable
of producing a given level of output. Since an iso product curve represents those combinations
which will allow the production of an equal quantity of output, the producer would be indifferent
between them. Iso product curve are therefore, called product indifference curves. They are also
known as Iso quants or equal product curve. This is explained with the help of a diagram.

Explanation: IP represents all those combinations with which the units of the product can be
produced. The shape of the iso-quants shows the degree of substitutability between the two
factors used in production.
PROPERTIES OF EQUAL PRODUCT CURVES

i. Sloping downwards: Iso product curves slope downwards from left to right. This is so
because if the quantity of a factor X is increase, the quantity of factor Y must be decreased so as
to maintain the same level of output.

ii. Convexity: Iso- product curves are convex to the origin. This is due to the fact that marginal
rate of technical substitution falls as more and more of X is substituted for Y.

iii. Perfect Substitutes: When the factors of production are perfect substitutes then one factor
can completely take the place of the other. They may, in fact, be regarded as on factor. In their
case, the marginal rate of technical substitution is constant. Hence, the equal product curves will
be a horizontal straight line instead of being convex to the origin.

iv. Complements: The complementary factors are those which are jointly used in production in
a fixed proportion. If one of these factors in increased, the other must also be increased at the
same time otherwise no additional output will be obtained, In this case, the equal product curves
will be right angled (i.e. One of the two arms being vertical and the other horizontal) at the
combination of the two factors used in fixed proportion.

v. Non-intersecting: Two iso product curves cannot cut each other


Types of Iso Quants

1. Linear Iso-quants: There is perfect substitutability of inputs. For examples, a given
output say 100 units can be produced by using only capital or only labour or by a numer
of combinations of labour and capital, say 1 unit of labour and 5 units of capitals or 2
units of labour and 3 units of capital and so on.

Likewise, a given a power plant equipped to burn either oil or gas, various amounts of
electric power can be produced by burning gas only, oil only or varying amounts of each.
Gas and oil are perfect substitutes here.

2. Right angle Isoquant.
Here, there is complete non substitutability between the inputs. For example, exactly two
wheels and one frame are required to produce a bicycle and in no way can wheels be
substituted for frames or vice versa. Likewise, two wheels and one chassis are required
for a scooter.

3. Convex Isoquant: This form assumes substitutability of inputs but the substitutability is
not perfect. For example, a shirt can be made with relatively small amount of labour(L1)
and a large amount of cloth(C1). The same shirt can be as well made with less cloth (C2).
If more labour(L2) is used because the tailor will have to cut the cloth more carefully and
reduce wastages.Finally , the shirt can be made with still less cloth(C3) ut the tailor must
take extreme pains so that labour input requirement increases to L3.


APPLICATION OF EQUAL PRODUCT CURVES

i. Applicable to agriculture: The isoquant technique is applicable to agriculture and to all lines
of manufacture.

ii. Substitution of some units: The marginal rate of technical substitution guides in the
substitution of some units of one input for some units of another input.

iii. Reduction in use of raw materials: In some cases, increased use of labor can help in making
a reduction in the use of raw materials because spoilage and wastage of material may be cut to
the minimum.

iv. Supervisory staff: Similarly, by adding to the supervisory staff, labor may be economized
of\r the introduction of machinery may cut down the use of labor.

v. Economical combination: The business man tries various permutations and combinations and
the Isoquant technique helps him in reaching the most economical combinations.


4. Explain the economics of scale?
Economies of Scale: An economy of scale exists when larger output is associated with
lower per unit cost.
Diseconomies of Scale: A diseconomy of scale exists when larger output leads to higher
per unit cost.
ECONOMIES (OR) ADVANTAGES OF LARGE SCALE PRODUCTION

i. Efficient use of capital equipment: There is a large scope for the use of machinery which
results in lower costs.

ii. Economy of specialized labour: Specialized labour produces a large amount of output and of
better quality.

iii. Better utilization and greater specialization in management: When the scale of
production is enlarged, there is fuller use of the managers time and ability. Also, he is able to
delegate some of his less important functions to his assistants and increasingly specialize in the
jobs where his ability is most fruitful.

iv. Economics of buying and selling: While purchasing raw material and others accessories, a
big business can secure specially favorable terms on account of its large custom.

v. Economics of the overhead charges: The expenses of administration and distribution per unit
of output in a big business are much less.

vi. Economy in Rent: A large-scale producer makes a savings in rent too.

vii. Experiments and Research: A large concern can afford to spent liberally on research and
experiments.

viii. Advertisement and Salesmanship: A big concern can afford to spend large amounts of
money on advertisement and salesmanship.

ix. Utilization of By-products: A big business will not have to throw away any of its by-
products or waste products.

x. Meeting Adversity: A big business can secure credit facilities at cheap rates.


DISECONOMIES (OR) DISADVANTAGES OF LARGE SCALE PRODUCTION

i. Over-Worked management: A large-scale producer cannot pay full attention to every detail.

ii. Individual tastes ignored: Large-scale production is a mass production or standardized
production. This results in a loss of custom.

iii. No personal element: The sympathy and personal touch, which ought to exist between the
master, and the men, are missing.

iv. Possibility of depression: Large-scale production may result in over-production. Production
may exceed demand and cause depression and unemployment.

v. Dependence on foreign markets: A large-scale producer has generally to depend on foreign
markets. This makes the business risky.

vi. Cut-throat competition: Large-scale producers must fight for the markets. There is wasteful
competition which does no good to society.

vii. International complications and war: When the large-scale produces operate on an
international scale, their interests clash either on the score of markets or of materials.

viii. Lack of adaptability: A large-scale producing unit finds it very difficult to switch on from
one business to another.

ECONOMIES (OR) ADVANTAGES OF SMALL SCALE PRODUCTION:

i. Prompt decision: The small manufacturer is capable of prompt decision and quick execution.

ii. Close Supervision: The initiative and sense of responsibility of a small producer have not
been sapped by routine.

iii. Personal contact with the employees: Personal contact with the employees, and a kind word
thrown now and then, will rule.

iv. Personal contact with the customers: Personal contact with the customers, again, sends
them away well satisfied and is productive of good results.

v. Demand is limited: The small-scale producers advantage is the greatest where the demand is
limited and fluctuating.

vi. Self-interest: The small businessman is usually the sole proprietor. Self interest is a strong
spur to his activity.


DISECONOMIES (OR) DISADVANTAGES OF SMALL SCALE PRODUCTION

i. Modern machinery: There is less scope for the use of modern machinery and labour-saving
devices. Hence cost per unit is high.

ii. Production is uneconomical: There is little scope for division of labour. The advantages of
division of labour are, therefore, lost of him. Hence production is uneconomical.

iii. Pushes up the cost: The small-scale producer is at a disadvantage in the purchase of raw
materials and other accessories. This pushes up the cost.

iv. No innovations: He cannot afford to spend large sums of money on research and
experiments. Hence he cannot make no innovations and thus reduce costs.

v. Higher overhead charges: Cost of rent, interest, advertisement, etc., per unit of output is
higher. That is, he has higher overhead changes.

vi. Instability: With his limited resources he cannot meet bad times.

vii. No cheap credit: He cannot secure cheap credit. This means higher costs.

viii. Wastage: By-products have to be thrown away as so much waste.


TYPES OF ECONOMIES AND DISECONOMIES OF SCALE TYPES OF ECONOMIES

A. Real Internal Economies: Real internal economies are associated with a reduction in the
physical quantity of inputs, raw materials, various types of capital (fixed or circulating) used by a
large firm.

i. Labour economies: When a firm expands in size this necessitates division of labour whereby
each worker is assigned one particular job, and the splitting of processes into sub-processes for
greater efficiency and productivity.

ii. Technical Economies: Technical economies are associated with all types of machines and
equipments used by a large firm. They arise from the use of better machines and techniques of
production which increase output and reduce per unit cost of production. It includes, economies
of indivisibility, economies of increased dimensions, economies of linked processes, economies
of the use of By-products, economies in power consumption.

iii. Marketing Economies: A large firm also reaps the economies of buying and selling. It buy
its requirements of various inputs in bulk and is, therefore, able to secure them at favorable terms
in the form of better quality inputs, prompt delivery, transport concessions, etc.

iv. Managerial Economies: A large firm can afford to put specialists to supervise and manage
the various departments. There may be a separate head for manufacturing, assembling, packing,
marketing, general administration, etc.

v. Risk-Bearing Economies: A large firm is in a better position than a small firm in spreading
its risks. It can produce a variety of products, and sell them in different areas.

vi. Economies of Research: A large firm possesses larger resources than a small firm and can
establish its own research laboratory and employ trained research workers.

vii. Economies of welfare: All firms have to provide welfare facilities to their workers. But a
large firm, with its large resources, can provide better working conditions in and outside the
factory. It may run subsidized canteens, provide crches for the infants of women workers and
recreation rooms for the workers within the factory premises.

B. Pecuniary Internal Economies: Pecuniary or monetary internal economies accrue to a large
firm solely through reductions in the market prices of its inputs.

i. It purchases raw materials in bulk at lower prices from its suppliers.

ii. It gets loans from banks and other financial institutions at low interest rates because it
possesses large assets and good reputation.

iii. It raises capital by floating shares at a premium and debentures at low interest rates in the
capital market.

iv. It advertises at concessional rates on a large scale in different media.

v. It transports large quantities of its commodity at concessional transport rates. Thus pecuniary
economics are realized from paying lower prices for the factors used in the production and
distribution of the product, due to bulk-buying by the firm as its size increases.

C. Real External Economies: Real external economies accrue to a firm in an industry due to
technological influences on its output which reduce its real cost of production.

i. Technical Economies: Technical external economies arise from specialization. When an
industry expands in size, firms start specializing in different processes and the industry benefits
on the whole.

ii. Economies of Information: As an industry expands, it specializes in collecting and
disseminating market information, in marketing the industrys product and in supplying the
firms with consultant services.

iii. Economies of By-products: When an industry is localized, it turns out large quantities of
waste materials, such as molasses in sugar industry and iron scrap in steel industry.

D. Pecuniary External Economies: Pecuniary external economies arise to firms in an industry
from reductions in factor prices.

TYPES OF DISECONOMIES

A. Real Internal Diseconomy: When a firm expands beyond an optimum level, a number of
problems arise such as factor shortages, lack of coordination and management, marketing and
technological difficulties, etc.

i. Managerial Diseconomy: There is a limit beyond which a firm becomes unwidely and hence
unmanageable. Supervision becomes less. Workers do not work efficiently, wastages arise,
decision-making becomes difficult, co-ordination between workers and management disappears
and per unit cost increases.

ii. Marketing Diseconomy: The expansion of a firm beyond a certain limit may also involve
marketing problems. Raw materials may not be available in sufficient quantities due to their
scarcities. The demand for the products of the firm may fall as a result of changes in tastes of the
people and the firm may not be in a position to change accordingly in the short period.

iii. Technical Diseconomy: A large scale firm often operates heavy capital equipment which is
indivisible. As the firm expands its size beyond the optimum level, there are repeated
breakdowns in plants and equipments and the firm may fail to operate its plant to its maximum
capacity. It may have excess capacity or idle capacity. As a result, per unit cost increases.

iv. Diseconomy of Risk-taking: As the scale of production of a firm expands, risks also increase
with it. An error of judgment on the part of the sales manager or the production manager may
adversely affect sales or production which may lead to a great loss.

B. Pecuniary Internal Diseconomy: Pecuniary internal diseconomy arises when the prices of
factors used in the production and distribution of the commodity increase.

C. Pecuniary External Diseconomy: Pecuniary external diseconomy arises solely through
increases in the market prices of inputs of an industry.


5.Explain Short run cost curves/decisions.


During the short period, the variable factors of production can be changed and the fixed factors
of production cannot be changed. The cost of production in the short run consists of both fixed
and variable costs. The cost output relationships, which is shown by the average cost curves
consists of the average fixed cost and the average variable cost.
MC- Marginal Cost
ATC- Average Total Cost
AVC- Average Variable Cost
AFC- Average Fixed Cost
In short run, the average cost of the firm declines to a minimum and then rises. To what extent it
declines depends on the proportion of fixed cost to total cost. The average cost curve is a U
shaped in the short run.
The short run cost-output relationship can be established as follows:
i) AFC falls as output rises from lower levels to higher levels.
ii) AVC first falls and then rises, so also the ATC curve.
iii) AVC curve starts rising earlier than ATC curve.
iv) The least cost level of output corresponds to the point L on ATC curve.
v) The marginal cost curve intersects both AVC curve and ATC at their minimum points.

6. Explain the Long run cost output relationship/Decisions.

Note: LAC curve will touch SAC3 curve at the least cost point.
LAC- Long Run Average Cost Curve
SAC Short Run Average Cost curve.
In the long run, a firm can change the fixed factors, ie, plant, equipment and thereby enlarge the
scale of operation and produce more output in the most efficient way. The long run cost output
relationship is shown by drawing a long run cost curves, as the long period is made up of many
short periods.
The long run cost of production is the least possible cost of production of producing any given
level of output, when all inputs become variable including the size of the plant.
Long run average cost is the long run total cost divided by the level of output. This curve depicts
the least possible average cost of production at different levels of output. It is the cumulative
picture of short run average cost curves. The short run average cost curves are also called plant
curves, since in the short run average cost curve corresponds to a particular plant.
The long run average cost curve initially falls with increase in output and after a certain point it
rises making a boat shape. Long run average cost curve is also called the planning curve of the
firm as it helps in choosing a plant on the decided level of output. The long run average cost
curve is called envelope curve, because it envelopes or supports a family of short run average
cost curve from below.Long run cost curve is a flattened U shape. This type of curve could exist
only when the state of technology remains constant