AHSEC Class 12 Economics Part A Notes: Unit – 3: Production and Costs

Part: A - Production Function

1. Greater application of the variable factors ensures better utilization of the fixed factor.
2. Greater application of the variable factor facilitates better division of labour, and
3. Greater application of the variable factor improves co-ordination between the factors.

Ans: Return to a factor refers to the behaviour of physical output owing to change in physical input of a variable factor, fixed factors remaining constant.

1. Constant returns to scale,
2. Increasing returns to scale and
3. Diminishing returns to scale.

1. Returns to factor related to the behaviour of total output when only input is increased and all other inputs are held constant. On the other hand, returns to scale refers to the increase in output when all inputs are increased in the same proportion.
2. Returns to a factor related in the short run. On the other hand, returns to scale relates in the long run.
3. Returns to a factor can be explained with the help of law of variable proportion from where we derive three stages of production function like increasing marginal return, diminishing marginal return and negative marginal returns. On the other hand returns to scale may be increasing, decreasing and constant returns.

1. There is no technological change.
2. The worker does not work without implements.
3. Perfect competition prevails in the market.

1. When average revenue is constant, it is equal to marginal revenue, as under perfect competition.
2. When average revenue is diminishing, it is greater than marginal revenue. It is true in situations of monopoly and monopolistic competition.
3. Marginal revenue can be zero or negative but not the average revenue.

1. Fixity of the factors: As more and more units of a variable factors are combined with the fixed factors, the latter gets over utilized hence the diminishing returns.
2. Factors of productions are imperfect substitute of each other.
3. The combination between gets distorted so that marginal product of the variable factor declines.

1. Isoquant is downward sloping to the right. This means that if more of one factor is used less of the other is needed for producing the same output.
2. A higher isoquant represents larger output.
3. No isoquants intersect or touch each other. If so it will mean that there will be a common point on the two curves. This further means that same amount of labour and capital can produce the two levels of output which is meaningless.
4. Isoquants need not be parallel to each other. It so happens because the rate of substitution in different isoquant schedules need not necessarily be equal. Usually they are found different and therefore, isoquants may not be parallel.
5. Isoquant is convex to the origin. This implies that the slope of the isoquant diminishes from left to right along the curve. This is because of the operation of the principle of diminishing marginal rate of technical substitution.

1. The prices of the two factors.
2. The total outlay of the firm.

1. Accounting costs relates to those costs only which involve cash payments by the entrepreneur. On the other hand economic costs take into account these accounting costs but they also include the amount of money the entrepreneur could have earned if he had invested his money and sold his own services.
2. Accounting costs are also called explicit costs whereas the economic costs include both accounting costs and implicit costs.

1. Material cost.
2. Wages.
3. Other cost.

1. Law of returns.
2. Size of the plant.
3. Period under consideration.
4. Level of capacity utilization.
5. Prices of factors of production.

1. Internal economies.
2. External economies.

1. Perfect competition prevails in the input market.
2. The market price of inputs are given and fixed.
3. The marginal product of every input in self-dependent, that is not dependent on the other.

1. Input may be used to produce a goods or services. On the other hand, output means creation of utility.
2. Input is essential to produce output. On the other hand, it may not be always possible that using inputs creates output.
3. The inputs are raw-materials. But the outputs are final goods.

1. The fixed inputs are that input which does not vary in the short period. On the other hand, variable inputs are those which vary both in short or long period.
2. Fixed inputs for example, machinery, and salary of permanent employees. On the other hand variable inputs for example, raw materials, wages of labour etc.
3. Fixed input and variable input are differentiated only in the short period. But there is no distinction between the two in the long period.

1. Short period is such type of period in which producers does not change all the factors. But on the other hand, long period is such type of period in which producers changes all the factors.
2. In the short period, producer changes its production only by changing variable factor. On the other hand, in the long period, a producer changes its production both by fixed and variable factors.
3. In the short period demand plays an active role for determining price of the commodity. On the other hand, in the long period both demand and supply determine price of the commodity.

1. As we increase the amount of an input, MP rises AP being the average of marginal products, also rises, but rises less than MP.
2. The average product curve slopes upwards as long as the marginal product curve is above it. It makes no difference whether the MP curve itself is sloping upwards or downwards.
3. When MP falls sufficiently, it becomes less than the prevailing AP and the later (i.e. AP) also starts falling. So MP and AP both are inversely U shaped.
4. The slope of the AP curve depends on whether MP is above or below AP. When MP is above AP, the AP curve slopes upwards and when MP is below AP, the AP curve slopes downwards.
5. MP can be zero and negative but AP is always positive.

1. When marginal product increases, total product increases at an increasing rate.
2. When marginal product falls but remains positive total product increases at a decreasing rate.
3. If marginal product is constant over a range of production, it implies that the total product increases at a constant rate.
4. If marginal product is negative, then total product falls.

1. AR increases as long as MR is higher than AR.
2. AR remains constant when MR is equal to AR.
3. AR falls when MR is less than AR.

1. Both average cost and marginal cost are obtained from total cost as under:

2. When average cost falls with an increase in output (upto q, level of output as shown marginal cost always remains lower than average cost.
3. When average cost is rising, marginal cost remains above average cost. In other words, marginal cost rises faster than average cost (beyond q1 level of output).
4. Marginal cost and average cost are equal when average cost in minimum (at q1 level of output).

1. Abnormal profit.
2. Normal profit.

1. Shows the situation of abnormal profits. The producer will be in equilibrium at point E (where MC = MR). Therefore, OQ will be the profit maximizing output for the producer. At this level of output (i.e. OQ), average cost is QC which is lower than the market price QE (=OP). Producer is earning CE (price minus average cost) per unit profit. Total profits are given by the area BPEC (per unit profit x quantity of output). These are super normal profits which are over and above the total costs. Remember, total costs include normal profits.

2. Shows the situation of abnormal losses. Here E is the equilibrium point where MC = MR and OQ is the equilibrium output. At this level of output, price QE (=OP) is lower than level of average cost which is QC. Firm is here incurring losses as P < AC. CE is the loss per unit of output. Total losses amount to area PBCE (CE x OQ). Hence, in the short run, there are three conditions of equilibrium, (i) MC = MR (ii) MC must be rising and (iii) PAVC.
3. Shows the situation of normal profits. Here market price (OP) is equal to producer’s average cost of production (QE) at equilibrium level of output. OQ is the equilibrium level of output as MC curve intersects MR (=AR) curve at this level of output. At OQ level of input MC = MR = Price. Abnormal profits or loss is here nil.

1. Behaviour of cost of production.
2. Availability of factors of production.
3. Nature of goods.

1. Market price is equal or greater than minimum long run cost curve – In the diagram, it shows that market price (p) is greater than the minimum average cost (LAC) and the price curve is intersect by LMC curve at point E. At that point E, LMC and LMR or price are equal at OQ level of output. According to long run condition of profit maximization of a firm, price must be equal to minimum long run average cost or greater than average cost. This condition is fulfilled at that level of OQ amount of output. In the diagram, it is shown that at OP price, the firm produces OQ level of
2. Market Price is less than minimum average cost – If the market price (P1) is less than minimum average cost then the firm will not be able to earn positive supply of a commodity. Because, for equilibrium and maximum profit of a firm, the price is always equal or greater than long run marginal cost. But, in the diagram the market is less than average cost. So, at the price the production is zero. The long run supply curve is the rising part of the Marginal cost curve which rising upward from the minimum point of long run average cost curve. In the diagram (A) E, M part is the long run supply curve of a firm.

1. There is no change in any change in the price of the factor of production.
2. There is no in the technique of production.
3. There is no change in the goal of the firm.
4. There is no change in the price of the related goods.
5. There is no change in business expectation.
6. The government policy of relating to the price and production of the commodity does not change.

1. The law of supply does not apply strictly to agricultural product whose supply is governed by natural factors.
2. Supply of goods having social distinction will remain limited even if their price tends to rise.
3. At a given point of time, sellers may be willing to sell more of perishable commodity even at a lower price.

1. Technological Change: When there is technological improvement, output is produced at lower cost. Lower cost of production increases the supply of the commodity. The supply curve shifts to the right.
2. Price of Other Goods: When price of a substitute good increase, the quantity supplied of the concerned good decreases and there is backward shift of the supply curve. Supply curve shifts forward in case price of the substitute good decreases.
3. Price of Factors of Production: If factor price decreases, cost of production also decreases. Accordingly supply increases and the supply curve shifts to the right. If factor price increases, supply tends to decline and there is a backward shift in supply curve.
4. Number of Firms: Increase in the number of firms implies increase in market supply and conversely decrease in number of firms reduces the market supply of the commodity.

1. Improvement in technology leading.
2. Reduction in factor prices, causing fall in cost of production.
3. Price substitute goods fall in the market.
4. Increase in number of firm in the industry. It causes increase in market supply even when price of the commodity remain the same.
5. High business expectation. It prompts the producers to increase investment accordingly, supply increases.
6. Shift in goal of the firm from profit maximization to sales maximization.
7. Decrease in taxation or grant of subsidy.

1. Use of outdated technology, causing fall in efficiency and rise in case of production.
2. Increase in factor price, cause increase in cost of production.
3. Rise in price of substitute goods.
4. Decrease in number of firm in the industry.
5. Low business expectations. It prompts the producer to reduce investment according supply reduces.
6. Shift in goal of the firm from sales maximization to profit maximization.
7. Increase in taxation or withdrawal of subsidy. It prompts the producers to restrict supply of their product.