MANAGERIAL ECONOMICS (MODULE-4) BCA

DEMAND FORECASTING
This involves prediction of demand at industry, firm, plant or product levels. This is of 2 types
such as; Microeconomic Forecasting & Macroeconomic Forecasting.
 MANAGERIAL ECONOMICS (MODULE-4) BCA

THEORY OF PRODUCTION
Q1. How the firm reaches of Equilibrium point with optimal combination of factors of
production?
Answer: Firm is a production unit. Always a firm wants to produce a product at optimal
combination of factors of production. Here we study the use of production function in the choice
of the optimal combination of factors by the firm. Here will examine 2 cases in which the firm is
faced with a single decision namely maximizing output for a given cost and minimizing cost
subject way given output. Both these decision comprised cases of constraint profit, maximization
in a single period.

In second part we will considered the case of unconstrained profit maximization by the
expansion of output over time.

In both these cases, it is assumed that the firm can choose the optimal combination of factors that
it can employee any amount of any factor in order to maximize its profit. The assumption is valid
if firm is in long-run. In the short-period due to pressure of demand output can be expanded by
expanding variable factor where usually capital is constant.

Assumption: -
1. The goal of the firm is profit maximization.
2. The price of output is given.
3. The price of factor are given.
4. The producer must be a rational producer.

ISOQUANTS
Like IC in consumption, isoquants are considered as IC in production. Isoquants are also called
as equal product curves. As isoquants represents all those input combination which are capable
of producing the same level of output.

ISOQUANT MAP
An isoquant map represt all the isoquant which are the preference of the producer to produce the
output with different combinations of input. Combination of inputs laying on higher isoquant
yields higher level of output and preferred. Combinations of inputs laying on a lower isoquant
yields a lower level of output.
MRTS
Marginal Rate of Technical Substitution or MRTS refers to the rate at which factors can be
substituted at the margin without altering the level of output. In other words MRTS of Labour for
capital may be defined as the number of units of capital which can be replaced by one unit of
labour, the level of output remaining uncharged.
 MANAGERIAL ECONOMICS (MODULE-4) BCA

Table
Factor combination Units of labour Units of capital MRTS LK

A 1 12 -
B 2 8 4
C 3 5 3
D 4 3 2
E 5 2 1

Diagram

The Marginal Productivity

Q1. Critically Examine the Marginal Productivity theory of distribution?

Or
What is the role of Marginal Productivity in determining factor price?
Answer: For a long time Marginal Productivity theory of distribution has held the field in the
matter of explaining how national income in distributed among the various factor of production.
In other words how the price or reward of these factor of production are determined by its MP.

It is the entrepreneur who buys the services of the various factor. He is the agent through whom
the various factor get their rewards in the form of rent, wages, interest etc. The entrepreneur
works for profit he can only pay price for a factor which he finds just worth while obviously, he
cannot afford to pay more the MP. On the other hand since there is open competition nobody will
accept less than MP. That is how MP determines the remuneration or the price of the factor of
production acts in the principle of substitution. He substitute one factor for another till the MP of
all factors are equalized in the sense of being proportionate to their respective remuneration. In
this way he maximizes his profit.

By the MP of factors of production we mean the additional made to total production by the
employment of the marginal unit, that is the unit which the employer thinks just worth while
employing. At the margin of employment, the payment made to the factor concerned in just
equal to the value of the additional made to the total production on account of the employment of
the additional unit of a factor. If for instance, the prevailing wage is less than the MP, then more
labour will be employed. Competition among the employers will raise the wages to the level of
MP. On the other hand, if the MP < wages, the employers are loosing and they will reduce there
demand for labour. As a result the wage will comedown to the level of MP. In this way by
competition, wage tends to be equal to the MP.
 MANAGERIAL ECONOMICS (MODULE-4) BCA

The MP curve show the diminishing marginal product of labour as more units of it are employed.
The prevailing wage rate which an employer must pay is equal to OW, then it will be profitable
for the employer to go on employing additional workers until the marginal product of labour
becomes equal to the prevailing wage rate OW. Then the employer will employ OL units of
labour. He would not employ more than OL amount of labour as the marginal product of labour
will fall below the wage rate OW and he would therefore be incurring losses on the employment
of marginal workers beyond OL. Thus the employer would be maximizing his profits by
equalizing the marginal product with the wage rate OW.

A marginal product schedule or curve shows a particular wage-employment relationship. In

clarkia analysis, aggregate supply curve of a labour has been assumed to be perfectly inelastic.
Given the total supply of labour in the economy, the wage rate will be determined by the
marginal product of the available amount of labour assuming that all labour get employment. If
the labourers compete with each other for obtaining jobs, they will bid the wage rate down if
some of them find themselves unemployed. The employer will bid the wage rate up if the
prevailing wage rate is smaller than the marginal product of available labour force. This is so
because at the wage rate lower than marginal product the employers demand for labour force will
be more than the available number of labour.

In the above diagram, MP curve represents diminishing marginal product of labour as more units
of labour are employed in the economy, assuming the quantities of other factors used as
unchanged. If the available quantity of labour force is OL in the whole economy the marginal
product of OL quantity of labour is LD. The wage rate will be determined by this marginal
product LD and therefore, equilibrium wage rate will settle in the market will be equal to LD or
OW. At a higher wage rate L1D1. (=OW1), the employer will employ OL1amount of labour
leaving LL1 amount of labour unemployed.

On the other hand, at a lower wage rate than LD say L”D”, the employers will demand OL”
amount of labour. Since there profits will be maximum if they are employing OL” amount of
labour at the wage rate L”D” (=OW”), but the available amount of labour is OL. Thus at a lower
wage rate than LD (=OW) the demand for labour by the employers will be greater than the
available quantity of labour. Thus given the quantity of labour in the country, wage rate is
determined by marginal productivity of labour.
 MANAGERIAL ECONOMICS (MODULE-4) BCA

Limitation: -
In other words it is assumed that the existing amount of labour in the economy is fully employed.
The marginal productivity theory fails to explain the actual rewards earned by the factor of
production. We give below the various crowns on which the MP theory is criticized.

i) It assumes that all the units of factor are homogeneous: -

In this theory it assumes that all the units of a factor are homogeneous; so that any one unit is as
good as any others. This is not actual the case. All labours are not alike. They are of varying
efficiency, non are the all the unit of land similar. The capital equipment is also different types.
Thus we can not talk-off MP of a factor in general.
ii) Different factors are capable of being substituted for one another: -
It is assumed that different factors are capable of being substituted for one another. So that at the
margin it is possible to use a little more land or a little more labour or capital etc. If this
substitution is not possible, MP of this various facto may remain unequal. Actually it is not
always possible to substitute labour for capital and vice versa. Different factor of production or
not close substitute for one another.
iii) The amount of factor used can be continuously varied: -
It is also assumed that the amount of factor used can be continuously varied. So that it is possible
to apply a little more or a little less of the same factor. If this can not be done, as is sometimes
the case, the use of the factors cannot be pushed to the point at which its marginal productivity
becomes equals to its price.
iv) The factor of production are mobile as between various uses: -
It is assumed that the factors of production are mobile as between various use, we know hand
hacks, Mobility nor are labour and capital perfectly mobile. If a factor cannot move one use to
another, its MP is the various employment may remain unequal.
v) Supply of facto is fixed: -
It is objected that theory assumes that supply of factor is fixed. In actual practice the reward
enjoyed by factor does affect its supply. The theory only approaches the problems from the side
of demand. It is thus a one-side explanation.