Passage Based Questions: Production and Costs | Economics Class 11 - Commerce PDF Download

Passage - 1

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A production function is defined for a given technology. It is the technological knowledge that determines the maximum levels of output that can be produced using different combinations of inputs. If the technology improves, the maximum levels of output obtainable for different input combinations increase. We then have a new production function. The inputs that a firm uses in the production process are called factors of production. In order to produce output, a firm may require any number of different inputs. However, for the time being, here we consider a firm that produces output using only two factors of production – labour and capital. Our production function, therefore, tells us the maximum quantity of output (q) that can be produced by using different combinations of these two factors of productions Labour (L) and Capital (K). We may write the production function as q = f(L, K).

Q1: What does a production function represent, and what factors determine the maximum levels of output that can be produced?
Ans:

• A production function represents the relationship between the inputs (factors of production) and the maximum levels of output that can be produced. 
• The technology used determines the maximum output achievable for different input combinations.

Q2: What are the factors of production typically used in the production process, and which two factors are considered in the context of this discussion?
Ans:

• The factors of production can include various inputs, but in this context, the discussion focuses on labor and capital as the two factors used to produce output.

Q3: How is a production function typically expressed, and what does the equation q = f(L, K) represent in this context?
Ans:

• A production function is often expressed as q = f(L, K), where "q" represents the maximum quantity of output that can be produced using different combinations of labor (L) and capital (K). 
• This equation describes the relationship between these factors and the resulting output.

Passage - 2

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As we hold one factor fixed and keep increasing the other, the factor proportions change. Initially, as we increase the amount of the variable input, the factor proportions become more and more suitable for the production and marginal product increases. But after a certain level of employment, the production process becomes too crowded with the variable input. 

Q1: How do factor proportions change as one factor is held fixed and the other is increased in the production process?
Ans: 

• Factor proportions change as the variable input is increased. 
• Initially, they become more suitable for production, and the marginal product of the variable input increases.

Q2: What happens to the production process when the level of employment for the variable input goes beyond a certain point?
Ans:

• When the level of employment of the variable input exceeds a certain point, the production process becomes overcrowded with that input.

Q3: How does the change in factor proportions impact the marginal product of the variable input in the production process?
Ans:

• Initially, with changing factor proportions, the marginal product of the variable input increases, indicating increased efficiency and output. 
• However, beyond a certain level of employment, this efficiency declines due to overcrowding, leading to a decrease in the marginal product.

Passage - 3

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When a proportional increase in all inputs results in an increase in output by the same proportion, the production function is said to display Constant returns to scale (CRS). When a proportional increase in all inputs results in an increase in output by a larger proportion, the production function is said to display Increasing Returns to Scale (IRS) Decreasing Returns to Scale (DRS) holds when a proportional increase in all inputs results in an increase in output by a smaller proportion. For example, suppose in a production process, all inputs get doubled. As a result, if the output gets doubled, the production function exhibits CRS. If output is less than doubled, then DRS holds, and if it is more than doubled, then IRS holds.

Q1: What is meant by Constant Returns to Scale (CRS) in a production function, and how is it observed in terms of input and output proportionality?
Ans:

• Constant Returns to Scale (CRS) in a production function occurs when a proportional increase in all inputs leads to an increase in output by the same proportion. 
• If doubling all inputs results in output doubling, CRS is observed.

Q2: How is Increasing Returns to Scale (IRS) defined in the context of a production function, and what occurs when all inputs are proportionally increased?
Ans:

• Increasing Returns to Scale (IRS) occurs when a proportional increase in all inputs results in an increase in output by a larger proportion. 
• If doubling inputs leads to an output increase greater than doubling, IRS is present.

Q3: What does Decreasing Returns to Scale (DRS) indicate in a production function, and what happens when all inputs are proportionally increased?
Ans:

• Decreasing Returns to Scale (DRS) in a production function implies that a proportional increase in all inputs results in an increase in output by a smaller proportion. 
• If doubling inputs results in an output increase less than doubling, DRS is evident.

Passage - 4

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To produce any required level of output, the firm, in the short run, can adjust only variable inputs. Accordingly, the cost that a firm incurs to employ these variable inputs is called the total variable cost (TVC). Adding the fixed and the variable costs, we get the total cost (TC) of a firm TC = TVC + TFC.

Q1: In the short run, which inputs can a firm adjust to produce the required level of output, and what term is used to describe the cost associated with these inputs?
Ans:

• In the short run, a firm can adjust only its variable inputs to produce the required level of output. 
• The cost associated with these variable inputs is known as Total Variable Cost (TVC).

Q2: How is the Total Cost (TC) of a firm calculated, and what does the equation TC = TVC + TFC represent?
Ans:

• The Total Cost (TC) of a firm is calculated by adding the Total Variable Cost (TVC) to the Total Fixed Cost (TFC). 
• The equation TC = TVC + TFC represents the relationship between the total cost, variable cost, and fixed cost incurred by the firm.

Q3: Why is it essential for firms to distinguish between fixed and variable costs in their cost analysis?
Ans:

• Distinguishing between fixed and variable costs is crucial for firms to make informed decisions regarding cost management and pricing strategies. 
• Fixed costs do not change with changes in production levels, while variable costs do, which impacts a firm's profitability and pricing decisions.

Passage - 5

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Marginal cost is the additional cost that a firm incurs to produce one extra unit of output. According to the law of variable proportions, initially, the marginal product of a factor increases as employment increases, and then after a certain point, it decreases. This means initially to produce every extra unit of output, the requirement of the factor becomes less and less, and then after a certain point, it becomes greater and greater. As a result, with the factor price given, initially the SMC falls, and then after a certain point, it rises. SMC curve is, therefore, ‘U’-shaped.

Q1: What is marginal cost, and how is it defined in the context of a firm's production process?
Ans: 

• Marginal cost is the additional cost a firm incurs to produce one extra unit of output. 
• It measures the increase in total cost when production is increased by one unit.

Q2: How does the law of variable proportions relate to the behavior of the marginal product of a factor as employment increases in the production process?
Ans: 

• According to the law of variable proportions, the marginal product of a factor initially increases as employment of that factor increases. However, after a certain point, it starts to decrease.

Q3: How does the behavior of the marginal product of a factor influence the shape of the Short-Run Marginal Cost (SMC) curve, and why is it described as 'U'-shaped?
Ans:

• The behavior of the marginal product of a factor results in a 'U'-shaped SMC curve. Initially, as the factor requirement decreases for each extra unit of output, SMC falls. 
• After a certain point, as the factor requirement increases for additional output, SMC rises. This pattern creates the 'U' shape in the SMC curve.

Passage - 6

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IRS implies that if we increase all the inputs by a certain proportion, output increases by more than that proportion. In other words, to increase output by a certain proportion, inputs need to be increased by less than that proportion. With the input prices given, cost also increases by a lesser proportion. For example, suppose we want to double the output. To do that, inputs need to be increased, but less than double. The cost that the firm incurs to hire those inputs therefore also need to be increased by less than double. What is happening to the average cost here? It must be the case that as long as IRS operates, average cost falls as the firm increases output.

Q1: What does Increasing Returns to Scale (IRS) imply in terms of the relationship between inputs and output, and how does it affect the cost of production?
Ans:

• IRS implies that when all inputs are increased by a certain proportion, the output increases by more than that proportion. 
• This means that to increase output by a certain percentage, inputs need to be increased by less than that percentage, resulting in a cost increase by a lesser proportion.

Q2: In the context of IRS, if a firm wants to double its output, what happens to the inputs and the cost incurred?
Ans:

• To double the output, inputs need to be increased by less than double, leading to a cost increase by less than double.

Q3: What is the relationship between Increasing Returns to Scale and average cost, and how does average cost behave as long as IRS is in effect?
Ans:

• As long as IRS is operating, average cost falls as the firm increases output. 
• This means that the average cost of production decreases as the firm expands its output due to the efficiency gained from increasing returns to scale.