The document details principles of economics, focusing on production costs, factors of production, and their classifications. It explains the distinction between economic goods, which incur costs, and free goods, which do not, alongside concepts such as total cost, fixed and variable costs, and economies of scale. Additionally, it discusses the law of diminishing returns and the implications of marginal costs and revenue on production decisions.

1. Chapter 4
PRINCIPLES OF ECONOMICS
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2. Whenever an individual creates
goods and services, costs or expenses
crop up. These are the costs of
production. For instance, workers get
their wages for their labor. The
Landlords get their rents while the
entrepreneurs acquire their normal
profits.

3. Goods produce by man are
called ECONOMIC GOODS.
There is a cost in economic
goods. However, there are
goods which are produced
without costs. These are
produced by nature. Such
goods are called FREE GOODS.

4. In the production of goods and
services, the various factors of
production receive their
corresponding payments like
wages, rents, interests and
normal profits.

5.  Land – An original gift of nature. It
includes soil, rivers, lakes, oceans,
mountains, forests, mineral resources,
and climate.
 Labor – an exertion of physical and
mental efforts of individuals. This applies
not only to workers, farmers or laborers,
but also to professionals like
accountants, economists or scientists.

6.  Capital – is a finished product which is
used to produce other goods. Example
of capital goods are machines as far as
economics is concerned
 Entrepreneur – is the organizer and
coordinator of the land, labor and
capital.

7. Factors of Production – are
called the inputs of
production, and the goods
and services that have been
created by the inputs are
called outputs of production.

8. Factors of Production are classified as :
 Fixed factor (fixed input)– remains constant
regardless of the volume of production. This
means whether you produce or not, the
factors of production is unchained. Ex., land &
capital.
 Variable factor (variable input) – it changes in
accordance with the volume of production.
No production means no variable factor. More
production means more variable factors. Ex.,
labor & entrepreneur.

9. The process of transforming
both fixed and variable inputs
into finished goods and
services is called theory of
production.

10. Such technical relationship between
the application of inputs
(factors of production) and
the resulting maximum
obtainable output is known as
production function.

11. The law of diminishing returns is also
known as the law of diminishing
marginal productivity. Where it states
that “when successive units of variable input (like
farmers) work with a fixed input (like 1 hectare of land),
beyond a certain point the additional product (output)
produced by each additional unit of variable input,
decreases”.

12. Farmers Total Product Marginal Product
1 40 0
2 55 15
3 75 20
4 100 25
5 120 20
6 135 15
7 145 10
8 145 0
9 135 -10
10 120 -15
3 – Hectare Rice Field

13. It is noted that in the work
combination of variable input and fixed
input, total output and additional output
(or marginal product) increase up to a
certain point. Beyond this point , the rate
of increase of total product declines,
and later on total product decreases as
more units of a variable factor are
employed.

14. In the case of marginal product,
it also diminishes, beyond a certain
point until it reaches negative
returns as more variable inputs are
added.

15. The message of the law is that there is a
proper combination of a variable input and a
fixed input in order to attain the maximum
output. It is not advisable to keep on
increasing the number of workers to work in
one place . If they are many, most of them
have nothing to do. They only hamper the
works of other farmers. A good knowledge of
factor proportion contributes to profit
maximization or production efficiency.

16. One of the determinants of Supply is the cost of
production. Producers have greater ability and
willingness to supply a product which has a lower
cost of production. As stated earlier, inputs or
resources are needed in the production of goods.
The prices of such resources are determined by
demand and supply. Resources which are scarce
signifies that there is a great demand for them to
command higher prices. This means higher cost of
production results to a higher price of the products.
However, COST does not only affect producers but
also the buyers.

17. 1. TOTAL COST - is the sum total cost of production. It is
composed of wages, rents, interests and normal
profits. These are also known as factor payments: wage
for labor, rent for land, interest for capital and normal
profit for entrepreneur. Normal profit is therefore part
of the total cost of production. It is an amount which
is sufficient to encourage an entrepreneur to remain
in business. In the case of pure profit, it is an amount
which is in excess of the cost of production. Total
cost is also equivalent to fixed cost plus variable cost.

18. 2. FIXED COST- is a kind of cost which remains constant
regardless of the volume of production. Even if there
is no production, there is still cost. Examples are the
expenditures on machines and buildings. Whether
you use these factors of production or not, you have
paid for them.
3. VARIABLE COST- is a kind of cost which changes in
proportion to volume of production . If there is no
production, there is no cost. More production means
more costs. Examples are wages, raw materials and
oil products.

19. 4. AVERAGE COST- This is also called unit cost. It is
equivalent to total cost divided by quantity.
AC = TC / Q
5. MARGINAL COST- is the additional or extra cost
brought about by producing one additional unit. It
id obtained by dividing change in total cost by
change in quantity.
MC = TC/  Q ; MC = TCc – TCp

20. 6. EXPLICIT COST- This is also called expenditure cost.
These are payments to the owners of the factors of
production like wages, interests, electric bills and so
forth.
7. IMPLICIT COST- another term for this cost is non-
expenditure cost. The factor of production belong to
the users. So, they do not pay. You do not pay to
your own properties.
8. OPPORTUNITY COST- is a foregone opportunity or
alternative benefit.

21. The effects of MC on AC are due to mathematical relationship. As long
as MC is less than AC, the latter falls. AC will only rise if MC is more
than AC.
PRODUCT COST TOTAL
COST
AC MC
1 160 160 160
2 140 300 150 140
3 120 420 140 120
4 140 560 140 140
5 160 720 144 160
6 180 900 150 180
7 200 1,100 157.14 200
MC is falling, it pulls
down AC.
MC = AC
at its lowest
amount. MC is
rising, it pulls up AC
but MC rises faster.

22. Cost
Units
MC
AC

23. Variable factors or inputs like labor, raw materials,
electricity, oil and so forth take a shorter time in
adjusting them to production process. However, in
the case of fixed factors or inputs like machines,
buildings, heavy equipment, or manufacturing plant
capacities, it takes a longer period of time for their
adjustments in accordance with the needs of
production.

24. SHORT RUN refers to a period of time which is too short to
allow an enterprise to change its plant capacity,
yet long enough to allow a change in its variable
resources.
LONG RUN refers to a period of time which is long enough
to permit a firm or enterprise to alter all its resources
or inputs (both fixed & variable factors).

25. Economies of Scale may be classified as external economies of scale
and internal economies of scale.
External economies of scale refers to those factors
which are outside the firm or enterprise, but
they contribute to the efficiency in terms of
increased output and decreased unit cost
of production. Examples are government policies,
electrification, transportation and communication facilities.

26. Internal economies of scale are the factors inside the
firm or enterprise which contribute to the
efficiency like division of labor, human resources development,
managerial specialization, proper use of machines and equipment,
favorable management policies, effective utilization of by-products and
modern techniques of production.

27. There are two techniques of production:
Labor-intensive technology means more labor inputs
and less capital inputs.
Capital-intensive technology means more capital
inputs and less labor inputs.

28. Cost of production refers to the total
payments by a firm to the owners of the
factors of production like land, labor, capital
and entrepreneur. These are other
expenditure-side of a firm in the process of
creating goods and services. However, revenue
is the income - side of a firm.

29. Total revenue = price times units sold
TR = P x Q
Total Revenue – Total Cost = profit

30. Under short-run period, a firm has both fixed cost and variable
cost. Under what conditions would a businessman operate or
shut down? The rule is:
TR > VC = operate
TR < VC = shut down
Under long-run period, all costs are variable. This means total
cost is equivalent to variable cost. The rules are:
TR > TC: produce more, operate
TR < TC: stop production
TR = TC: maintain production

31. Marginal revenue is the additional income of a firm brought about by
producing and selling one additional unit of a product. Clearly, the
production of one additional unit means additional cost of
production. Such additional cost is called marginal cost.
The rule is:
MR > MC = increase production
MR < MC = do not increase production

32. In one whole sheet of yellow paper.
1. State some examples under short run and
long run?
2. Discuss with examples for the appropriate
techniques of production.
3. Do you consider money as capital in
economics? Why?