Commerce Exam  >  Commerce Notes  >  Economics Class 11  >  Chapter Notes - Production and Costs

Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

Production

It is primarily concerned with the transformation of resources into commodities.

Production Function: Physical inputs are used in the production function. A firm's production function describes the relationship between output and production factors used in the manufacturing process. It displays the number of inputs required to produce the highest level of final output.

The production function is expressed using the following formula:

(Q = f x1 , x2)

Here, Q is equal to final units of output, x1 and x2 are the amount of production factor 1 and amount of production factor 2 respectively.

The above equation shows that production factors 1 and 2 can be used to produce the final units of output.

Types of Production Function

There are two types of Production Function.
1. Short-run Production Function: In this production function, one production factor is variable while the others are fixed. As a result, the law of return to a factor is applied. It is also referred to as the variable proportion type of production function.

It is a time frame that is insufficient to effect change in all inputs. The variable factors in this level of production can be changed.

2. Long-run Production Function: All production factors are variable in this production function. As a result, the law of diminishing returns to scale is applied. It is also referred to as the constant proportion type of production function.

It is a time period long enough to change all inputs, and all inputs are variable in the long run.

Total product or Total physical product: Total product is the sum of the final units of output produced by a firm using a given amount of inputs over a given time period. When all other factors of production are held constant, total product is the relationship between variable factors of production and final units of output. The total product can be expressed using the formula below:  
Total Product = ∑Qx
The formula above depicts the relationship between variable factors of production and the total output.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

Question for Chapter Notes - Production and Costs
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What does the production function describe?
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Average production

 The average production is the variable factor's per unit production.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics
Marginal product: It refers to the change in total product resulting from the employment of an additional unit of variable factor. In other words, it is the contribution of each additional unit of variable factor to output.

Relation between Total, Average and Marginal Product

Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

  1. When TP rises at an increasing rate, MP rises as well. 
  2. MP decreases as TP increases at a decreasing rate. 
  3. When TP is at its maximum, MP equals zero. 
  4. When TP starts to fall, MP becomes negative.

Concept of Supply (Producer Behaviour and Supply) Class 12 EconomicsConcept of Supply (Producer Behaviour and Supply) Class 12 Economics

  1. When MP is greater than AP, AP increases. 
  2. When MP equals to AP, AP is maximum and constant. 
  3. When MP is less than AP, AP decreases. 
  4. MP can be zero or negative, but AP remains positive. 
  5. AP rises even when MP falls, but MP should be higher than AP.

Returns to a factor: It describes the output behavior when only one variable factor of production is increased in the short run while fixed factors remain constant.

Law of variable proportion: The law of variable proportion states that when more and more units of variable factors are used to increase output, output initially increases at an increasing rate before falling.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

1. Stage I (Stage of Increasing Return to factor): TP Increases at an everincreasing rate: Initially, as more units of variable factors are combined with fixed factors, total physical production increases at an increasing rate, and MP rises.
The following are the reasons for the increased return:
(a) Underutilisation of fixed factor
(b) Indivisibility of factor
(c) Increased efficiency of variable factor 

Stage II (Stage of Diminishing Return to factor): TP increases at a decreasing rate: As more units of variable factors are combined with fixed factors, total product increases at a decreasing rate, while MP decreases but remains positive. At the end of this phase, TP is at its maximum and MP is zero.
The cause of diminishing returns is: 
(a) best use of fixed factor
(b) unsatisfactory factor substitutability Stage III (Stage of negative return to factor): TP falls: As more units of variable factors are combined with fixed factors, total output begins to fall and marginal product becomes negative.

Cause of negative return: 

(a) Inadequate coordination between fixed and variable factors.
(b) Excessive use of fixed factors

Economic Cost: Economic cost is the sum of explicit and implicit costs.

Explicit Cost: The actual money spent by a firm on the purchase and hiring of factor inputs for production is referred to as explicit cost. These are recorded in accounting books. For example, wage payments, rent, interest payments, raw material purchases, and so on.

Implicit cost: This is the cost of self-owned production resources used in the manufacturing process. Or the estimated value of inputs supplied by the owner. These are not recorded in the accounting books.

Normal profit: This is the bare minimum needed to keep the producers in business. In other words, it is the entrepreneur's minimum supply price. It is also known as an entrepreneur's wage.

Total cost: It refers to the total amount of money spent by a company on producing a given quantity of a commodity. The total cost is the sum of the total fixed and variable costs.

TC = TFC + TVC  or  TC = AC x  Q
TFC = TC - TVC  or  TFC = AFC  x  Q 

Features of Total Fixed Cost: 
(a) It remains constant at all output levels. Even at zero output level, it is not zero.
As a result, the TFC curve is parallel to the X-axis.
(b) Total cost at zero output level equals total fixed cost.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

Total variable cost

It is the cost that varies with the amount of output produced. It is zero at the output level of zero. The TVC curve is perpendicular to the TC curve. Excluding raw material costs, power expenses, and so on.

TVC = TC – TFC or TVC = AVC × Q

Features of Total variable cost: -
(a) When the output is zero, it is zero.
(b) It rises in proportion to the increase in output.
(c) Initially, TVC grows at a diminishing rate due to increasing returns, but later, it grows at an increasing rate due to diminishing returns.

Average cost

It is the cost of producing a commodity per unit. It is the sum of the average fixed and variable costs.

Average fixed cost 

It is the fixed cost of producing a commodity per unit.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

Features of AFC :
(a) As output increases, AFC decreases.
(b) A rectangular hyperbola is the shape of the AFC curve.
(c) It cannot cross the X or Y axes.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

Average variable cost: 
It is the variable cost of producing a commodity per unit. Because of the law of variable proportion, AVC is U-shaped.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

Relation between Short-Term Costs 

The total cost curve and the total variable cost curve remain parallel. Total fixed cost is equal to the vertical distance between these two curves. The TFC curve remains parallel to the X-axis, while the TVC curve remains parallel to the TC curve.
As the level of output increases, so does the vertical distance between the AFC and AC curves. The vertical distance between the AC curve and the AVC curve, on the other hand, continues to decrease, but these two curves never intersect because the average fixed cost is never zero.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

Relation between MC and AVC: When MC < AVC, AVC falls.
When MC = AVC, AVC is minimum and constant.
When MC > AVC, AVC rises. MC curve cuts AVC curve at its lowest point. Both curves are U-shaped and starts from same point.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

Relation between MC and AC: 
(i) when AC falls, MC < AC.
(ii) when AC rises, MC > AC.
(iii) when AC is constant and minimum, MC = AC.

Revenue:
Revenue is the amount of money earned from the sale of a product.
Total revenue is the total amount of money received by a company from the sale of a specific number of units of a commodity.

TR = AR x Q or TR = ∑ MR
TP = Price x Quantity sold.
Price = AR

Average revenue is the revenue received per unit from the sale of a commodity. The average revenue equals the price. The price of a commodity per unit is also referred to as AR.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics
When one more unit of output is sold, marginal revenue is added to total revenue.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

Relation between TR, AR, and MR when more quantity sold at the same price: under perfect competition. 
(a) At all levels of output, average revenue and marginal revenue remain constant, and the AR and MR curves are parallel to the x-axis. AR = MR
(b) Total revenue grows at a constant rate. The MR is constant, and the TR curve is a positively sloped straight line through the origin.

Relation between TR, AR and MR when more quantity by sold at the lower price or there is monopoly or monopolistic competition in the market.
(a) The slope of the average revenue and marginal revenue curves is negative. The MR curve is located beneath the AR curve. MR > AR
(b) Marginal revenue declines twice as fast as average revenue.
Concept of Supply (Producer Behaviour and Supply) Class 12 Economics
(c) As long as marginal revenue is decreasing and positive, total revenue increases at a decreasing rate. Total revenue is at its highest when marginal revenue is zero, and when marginal revenue becomes negative, TR begins to fall.

Question for Chapter Notes - Production and Costs
Try yourself:
What is the relationship between Total Product (TP) and Marginal Product (MP)?
View Solution

Relation between AR and MR (General relationship) 

AR is maximum and constant when MR = AR. MR, can be negative but not AR.

When MR < AR, AR falls. When TR rises at an increasing rate, MR and AR rise as well.

Concept of Producer’s Equilibrium: It refers to the stage in which the producer is making the most profit for the least amount of money and has no incentive to increase or decrease the level of output.
MR and MC Methodology: According to this approach, the conditions of producer equilibrium are: (a) MC = MR and also AR = MR, so AR = MR = MC. MC should be on the rise. (b) At the point of equilibrium, the MC curve should cut the MR curve from below.
Alternatively, after the equilibrium point, MC should be greater than MR due to an increase in output.

Normal Profit: -
This is a no-profit, no-loss situation that occurs when P = AC. It is the minimum return on investment that a producer expects from his capital in the business.

Break-even Point: - It happens when AR = AC or when (TR = TC). At this point, the firm generates no economic profit or normal profit. OR we can say it is simply covering all of its expenses.

Shut-down Point: - This occurs when a company only covers its variable costs; in this case, the company suffers a loss of fixed costs. (TR < TVC OR AR < AVC) 

Supply: The amount of a commodity that a firm or seller is willing to sell at different prices during a given period of time is referred to as supply..

The document Concept of Supply (Producer Behaviour and Supply) Class 12 Economics is a part of the Commerce Course Economics Class 11.
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FAQs on Concept of Supply (Producer Behaviour and Supply) Class 12 Economics

1. What is a production function?
Ans. A production function is a mathematical relationship that shows the maximum output that can be produced from a given set of inputs. It depicts the technological relationship between inputs and outputs in the production process.
2. What are the types of production functions?
Ans. The main types of production functions include linear production function, Cobb-Douglas production function, and Leontief production function. Each type represents different relationships between inputs and outputs in the production process.
3. How is the production function used in analyzing production processes?
Ans. Production functions are used to analyze the efficiency of production processes, determine the optimal combination of inputs to maximize output, and evaluate the impact of changes in input quantities on output levels.
4. What are the key characteristics of a production function?
Ans. The key characteristics of a production function include diminishing returns to scale, constant returns to scale, and increasing returns to scale. These characteristics determine how changes in input quantities affect output levels.
5. How does technology influence the shape of a production function?
Ans. Technology plays a crucial role in shaping the production function by determining the efficiency of input usage and the overall productivity of the production process. Advancements in technology can lead to shifts in the production function and improve overall output levels.
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