PRODUCTION AND COSTS

Two Mark/Four Mark questions

1.Explain the concept of Production Function
The production function of a firm is a relationship between inputs used and
output produced by the firm.
The inputs of a firm uses in the production process are called factors of
production
Q=f(L,K)
Where, L is labour and K is capital and Q is the maximum output that can be
produced.
2.What is the Law of Diminishing Marginal Product.Or What is Law of variable
proportions
When more units of variable input (labour) is combined with some quantity of
fixed input(Capital,Land),then total product and marginal product increases
intially but marginal product of variable factor(labour)will start falling. And it will be
zero and it can be negative also.which is called as Law of diminishimg marginal
product or Law of variable proportions.
3,Explain the relationship between the marginal product and the total product of
an input
Total Product Marginal Product Average Product

Total volume of goods Marginal Product is the Average Product is the

and services produced change in output per unit output per unit of
during a period of time of change in input. variable output
TP=∑MP (Or) MP=TPn-TPn-1 AP=Total
TP=AP×Variable factor (Or) product/Number of units
MP=ΔTP/ΔL of variable factor
TP increases at MP also increases AP also increses but less
increasing rate initially initially but it decreases. than MP
 but later it increases at
diminishing rate
TP is a positively sloped MP curve is inverse U AP curve is also inverse
curve shaped curve i.e. “∩’’ U shaped curve i.e. “∩’’
When TP is constant MP is zero AP never becomes zero
When TP is falling MP becomes negative AP becomes less than
MP

4.When does a production function satisfy Constant returns to scale(CRS)

When a proportional increase in all inputs(all inputs got doubled) results in an
increase in output in same proportion (output also got doubled) then production
function satisfies constant returns to scale
5.When does a production function satisfy Increasing returns to scale(IRS)
When a proportional increase in all inputs(all inputs got doubled) results more
than the proportional increase in output(more than double output) then
production function satisfies Increasing returns to scale (IRS)
6.When does a production function satisfy Decreasing returns to scale(DRS)
When a proportional increase in all inputs(all inputs got doubled) results lessthan
the proportional increase in output(less than double in output) then production
function satisfies Decreasing returns to scale (DRS)
7.Briefly explain the concept of cost function
The Cost function describes least cost(minimum) of producing each level of
output with given technology and with given prices of factors of production.
It shows the relationship between cost of production and output.
C=f(Qx)
C= Cost of production
F=function
Qx=Units of output produced
8.What are the total fixed cost, total variable cost, and total cost of a firm? How
are they related
Total fixed cost refers to the cost made by a firm to use fixed factors of
production.Which do not change with the change in output.There is TFC even
when production is zero.
Ex:Rent of a factory,Salaries of permanent employees.Insurance premium etc.,
Total fixed cost also known as Supplementary cost or Over head cost.
Total variavble cost refers to the cost made by a firm to use variable factors of
production. Which changes with the change in output.
Ex:Wages of daily labourers, Cost of fuel, Electricity charges, Price of
rawmaterials etc.,
Variable cost is also known as Special cost,Direct cost,or Prime cost.
Total cost is sum of Total fixed cost and Total variable cost
TC=TFC+TVC

Output TFC TVC TC

1 50 20 70
2 50 30 80
3 50 40 90
4 50 60 110
5 50 90 140
TFC is constant and do not change in short run and TFC curve is horizontal
straight line.
TVC increases when output increases due to increase in variable factor.(Labour)
It starts from origin,and it increases slowly intially and afterwards it increases at
an increasing rate.
TC curve alsofollows the same pattern, and it increases with the increase in
output and there is TC even production is zero.And TC curve touches TFC curve.
9.What are the Average Fixed cost,Average variable cost and Average cost of
firm?How are they related?
Average Fixed cost is defined as the total fixed cost per unit of output
AFC=TFC/Q
Average variable cost is defined as the total variable cost per unit of output
AVC=TVC/Q
Average cost is defined as total cost per unit of output
AC=TC/Q
AC is also defined as the sum of Average Fixed cost,Average variable cost
AC=AFC+AVC
AFC=AC-AVC
AVC=AC-AFC
AFC curve is a rectangular hperbola and falls continuously when output
increases.And AFC will never becomes zero,and it never touches x axis.
AVC and AC never intersect each other,if they intersect it means that AC and
AVC are equal at that point.AC and AVC decreases in the beginning reaches a
minimum and then it increases.
10.Can there be some fixed cost in the long run ?If not why?
No, there cannot be any fixed cost in the long run .In long run a firm has time to
change all factors of production.
11.What does the average fixed cost curve look like?Why does it look so?
AFC=TFC/Q and it is defined as the ratio of TFC to its output.
When TFC is constant AFC will decrease with increase in the output.,so AFC
decreases. Due to thisAFC curve is a rectangular hyperbola.And AFC will never
becomes zero,and it never touches x axis.
12.What do the short run marginal cost,average variable cost and short run
average cost curves look like?
SMC,AVC,SAC curves are all U shaped curves.This is due to law of variable
proportions.
13. Why does SMC curve cut the AVC curve at the minimum point of the AVC
curve?
SMC curve cut the AVC curve at the minimum point because when AVC is
falling SMC must be less than AVC.(To the left of Q1) and as AVC rises SMC
must be greater than AVC (To the right of Q1).So the SMC curve cuts the AVC
curve from below at the minimum point of AVC.
Diagram:

14. AT which point does the SMC curve cut the SAC curve?Give reason in
support if your answer
SMC curve cut the SAC curve at its minimum point from the below because as
long as SAC is falling SMC is less than SAC (To the left of Q2)
When SAC is raising SMC is greater than SAC (To the right of Q2)
Diagram:

15.Why is short run marginal cost curve U shaped

SMC curve is U shaped curve due to Law of variable proportions,
16.What do the LRMC LRAC curves look like
Both LRMC and LRAC curves are ‘U’ shaped. LRMC curve cuts the LRAC curve
from below at the minimum point of LRAC.
This is due to IRS, CRS DRS.(Increasing returns to scale, Constant returns to
scale, Diminishing returns to scale)