This document discusses concepts related to production functions and costs. It covers: - Production functions including fixed and variable inputs, short and long run production, and total, average and marginal products/curves. - The law of variable proportions, returns to scale, and isoquants/properties of isoquants. - Economies and diseconomies of scale. - Theory of costs including short-run total, average, and marginal cost curves and their relationships. - Determinants of cost and cost-output relationships in the short and long-run.

1. Unit 4: Theory of Production and Cost
Concept of Production Function, Fixed and Variable Inputs and Short and Long
Run, Total, Average and Marginal Products, Total, Average and Marginal Curves,
The Law of Variable Proportions: Returns to a Factor, What Are Isoquants?,
Characteristics or Properties of Isoquants, Returns to Scale, Economies and
Diseconomies of Scale Theory of Costs- Basic Concepts, Short-run Total Cost
Curves, Fixed and Variable, Short-run Average and Marginal Cost Curves,
Relationship between Average and Marginal Cost Curve, Average and Marginal

2. Production Function

4. Fixed Proportion Production Function
Capital
Labour
15
5
30
50
10 22
A = 100
B = 200
C = 500

5. Variable Proportion Production Function

6. Short-run Production
Law of variable proportion
No change in scale of production.
Factor ratio changes
There are barriers to entry and the firms can shut down but cannot
fully exist.

7. Long-run production

8. use of the available capital can be made only in periods of full
employment
considers only two inputs
shows constant returns to scale
neglects the complementarity of factors
perfect competition in the factor market
function is the aggregation problem
Criticisms of C-D Production Function
The Cobb-Douglas Production Function
Q = ALα Cβ

9. Law of Variable Proportions

10. Assumptions
Constant Technology Factor Proportions are Variable Homogeneous Factor Units Short-Run

11. Three Stages of the Law

12. Condition or Causes of Applicability
Under Utilization of Fixed Factor
Fixed Factors of Production
Optimum Production
Imperfect Substitutes
Applicability of the Law of Variable Proportions
Application to Agriculture
Application to Industries

13. Isoquant Curves Properties of Iso-quant Curve
The iso-quant curve is negatively sloped
The iso-quant curve is convex
Iso-quant curves cannot intersect
Upper iso-quant curves yield higher outputs
No iso-quant curve touches either of the axis, X or Y
Iso-quant curves need not be parallel to each other
Each iso-quant curve is oval-shaped

14. Iso-cost Lines

15. The Choice of Optimal Expansion Path

16. Law of returns to scale
1. Increasing Returns to scale.
2. Constant Returns to Scale
3. Diminishing Returns to Scale

17. Increasing Returns to Scale Diminishing Returns to Scale Constant Returns to Scale

18. ). Nature of the Industry
). Analysis of Cost of Production

19. Diseconomies of Scale of Production
Internal Diseconomies
(a) Inefficient Management
(b) Technical Difficulties
(c) Production Diseconomies
(d) Marketing Diseconomies
(e) Financial Diseconomies
(f) Marketing Diseconomies
External Diseconomies
(a). Diseconomies of Pollution
(b). Diseconomies of Strains on Infrastructure
(c). Diseconomies of High Factor

20. “Cost is the expense incurred in producing a commodity”
Cost Determinants
1. Level of output
2. Price of input factors
3. Productivities of factors of production
4. Size of plant
5. Output stability
6. Lot size
7. Laws of returns
8. Levels of capacity utilization
9. Time period
10. Technology

22. Cost-Output Relationship
C= f (S, O, P, T ….)
Cost-Output Relationship in the Short-Run
Units of
Output Q
Total fixed
cost TFC
Total
variable
cost TVC
Total cost
(TFC + TVC)
TC
Average
variable
cost (TVC /
Q) AVC
Average
fixed cost
(TFC / Q)
AFC
Average
cost (TC/Q)
AC
Marginal
cost MC
0 – – 60 – – – –
1 60 20 80 20 60 80 20
2 60 36 96 18 30 48 16
3 60 48 108 16 20 36 12
4 60 64 124 16 15 31 16
5 60 90 150 18 12 30 26

23. short-run cost-output relationship

24. Cost-output Relationship in the Long-Run