UNIT 3: Producer Behaviour and Supply

(13 marks) 32 Periods

Meaning of Production Function – Short-Run and Long-Run
Total Product, Average Product and Marginal Product. Returns to a Factor
Cost: Short run costs - total cost, total fixed cost, total variable cost; Average cost;
Average fixed
cost, average variable cost and marginal cost-meaning and their relationships.
Revenue - total, average and marginal revenue - meaning and their relationship.
Producer's equilibrium-meaning and its conditions in terms of marginal revenue-marginal
cost.
Supply, market supply, determinants of supply, supply schedule, supply curve and its
slope, movements along and shifts in supply curve, price elasticity of supply;
measurement of price elasticity of supply - percentage-change method.

PRODUCTION FUNCTION: - It is defined as the functional relationship between input and output for a
given state of technique.
Q= f (L, K….) Q= Output , f = functional relationship, L,K = Factors of production ( input)
Production function can be of two types:-
i) Short Run Production Function:- In the short run some factors are fixed & one is variable then the
proportion between fixed & variable factors change & the law which arise out of it is law of
variable productions or Returns to factor.
ii) Long Run Production Function:-In the long run nothing is fixed & all the factors change in the
same proportion. When all the factors change it is said that the scale of production is changed &
the law arises out of it is returns to scale.
FIXED AND VARIABLE FACTORS: Factors of production are classified into two factors:
i) Fixed Factors are the factors that do not change with the change in output in the short run. Example:
Machinery, equipment, building, permanent staff etc.
ii) Variable Factors are those factors which change with the change in output. Example: labour, raw
material, fuel etc.

TOTAL PRODUCT (TP) OR TOTAL PHYSICAL PRODUCT (TPP) :-

The total quantity of goods produced by a firm during a given period of time with given inputs.
TP= Σ MP
AVERAGE PRODUCT (AP) OR AVERAGE PHYSICAL PRODUCT (APP) :-
The output per unit variable input.
AP=TP/Q
Q = Variable inputs used
MARGINAL PRODUCT (MP) OR MARGINAL PHYSICAL PRODUCT (MPP):-
The change in total output by using one more unit of variable factor .
MP = Change in TP/ Change in units of variable factors
OR MP = ∆ TP/ ∆ Input
OR MPn = TPn – TP n-1

LAW OF VARIABLE PROPORTIONS (RETURN TO A FACTOR) : - It is operated in

short run. If some factors are constant and one factor is variable, the proportion between fixed & variable
factors change & by increasing the quantity of variable factors resulting output is affected. The effect on
output is called returns to factor.
Statement of the law:- The law states that as we increase the quantity of only one input keeping other input
constant initially MP increases than decreases and ultimately become negative. This can be studied in three
phases:

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Ist Phase ( phase of Increasing returns) :- As the variable factors are increased with the fixed factors, first
Marginal Product (MP) increases due to division of work & specialisation & therefore Total Product (TP)
increases at increasing rate. Average product (AP) also increases but below MP. MP rises & reaches
maximum in this stage.
IInd Phase ( Phase of Diminishing returns) :- In the second stage when optimum combination of fixed &
variable factors is already achieved then every increase in variable factors will reduce MP. When MP falls
TP increases at diminishing rate & AP after MP=AP starts falling. At the end of the stage MP becomes zero
& TP is maximum. A rational producer operates under this stage.
III Phase (Phase of Negative returns) :- If the producer continues to increase variable factor, MP becomes
negative , TP starts falling & AP also falls but never touches zero. A rational producer never operates under
this stage.

Explanation Of the law By Schedule & Curve:-

Land Labour TP MP Stage
(hectare)
1 1 2 2 Increasing
1 2 5 3 Returns
1 3 9 4
1 4 12 3 Diminishing
1 5 14 2 Returns
1 6 15 1
1 7 15 0
1 8 14 -1 Negative
1 9 12 -2 Returns
Explanation through curve:-

The diagram shows three stages

In first stage MP increases till point A & TP
increases at increasing rate till A’. AP also increases
but below MP
In second stage MP starts falling, TP increases at
diminishing rate & AP increases till MP=AP then
AP also starts falling.
In third stage MP becomes negative after B point &
TP also falls.

A’ = Point of inflexion where slope of TP changes.

After this point MP starts declining.

Assumptions of Law of variable proportions:-

i) The firm operates in the short run
ii) The state of technology remains constant
iii) All units of variable factors are homogeneous and equally efficient.
iv) There must be some fixed factors.
v) Factors of production- fixed and variable are not perfect substitutes of each other.
REASONS BEHIND APPLICATION OF LAW OF VARIABLE PROPORTIONS:
The reasons for Increasing Returns to factor:
i) Division of labour & specialisation:- As the no. of variable factors increase with some amount of
fixed factor variable factors ensures better division of work leading towards specialisation &
therefore increases production at increasing rate.
ii) Better Utilisation Of fixed Factors:- In the beginning when variable factors are increased with
fixed factors, fixed factors are underutilised, fixed factors are better utilised with the variable
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 factors, so Increasing returns are obtained till optimum combination of fixed & variable factors are
not achieved.
iii) Indivisibility of factors:- The factors employed in the production process are indivisible, i.e. they
cannot be divided into smaller parts, thus optimum combination is there & so increasing returns are
obtained as more variable factors are used with fixed factors.
The reasons of diminishing returns to factor:-
iv) Optimum use of Fixed Factors: When variable factors are increased so much that optimum
combination of fixed & variable factors is achieved, then returns starts diminishing if further
variable factors are increased.
v) Lack of Perfect substitutes:- All factors of production are in scarce supply. When there is an
imperfect substitutes of a factor with another factor, returns starts diminishing.
vi) Some factors are fixed:- Some factors are kept constant , after a point these fixed factors are
completely utilised, after which they are required to be increased. If they are constant, diminishing
returns are obtained.
The reason of Negative returns to factor:-
vii) Over utilisation of fixed factors :- this is due to fixity of fixed factors, which results in negative
returns after a point if variable factors are continued to be increased.
viii) Overcrowding & Mismanagement: When factors are increased too much the productivity per
worker falls. More labour than required is disturbing each other & productivity falls. It starts
creating problem for management.
Postponement of the law is possible when there is :-
i) Improvement in technology
ii) Some substitutes of fixed factors are discovered
iii) Quality of raw material is enhanced
iv) Research & development, innovations
v) Training to the workers to enhance productivity

COST CONCEPTS
Meaning
COST OF PRODUCTION : Expenditure incurred on various inputs to produce goods and services.
Cost function : Functional relationship between cost and output.
C=f (q) Where f = functional relationship
c= cost of production
q=quantity of product
MONEY COST : Money expenses incurred by a firm for producing a commodity or service.
Money Cost in economics comprises of two elements: explicit cost and implicit cost.
EXPLICIT COST: Actual money expenditure on inputs is termed as explicit cost. Example :- Rent,
interest, wages, insurance premium etc. which is recorded in the accounts book.
IMPLICIT COST :- Estimated money value of inputs supplied by the owners of production unit, including
normal profit, is termed as implicit cost. Main examples are: estimated salary of the owners, estimated
interest of own money invested by the owners, estimated rent of the owner’s building, etc.
NORMAL PROFIT is that minimum profit which the owners of business must get in the long run for
remaining in the current business rather than shift to the next best alternative business.
FIXED COST & VARIABLE COST :

TOTAL FIXED COST (TFC) - Fixed costs do not change with the change in output. They are sum of
expenditure incurred by the producer on the purchase or hiring of fixed factors. Example: Expenditure on
machinery, equipment, building, wages of permanent employees, insurance premium, rent etc. They are
called as supplementary cost. The concept of TFC is explained with the help of a schedule & curve:
Output TFC ( Rs)
0 10
1 10
2 10
3 10
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Curve:-

TFC curve is horizontal to x axis

As fixed cost remain constant at all levels of output-
q,q1,q2 etc.

TOTAL VARIABLE COST (TVC) : Variable cost change directly with the change in output. It increases
when output increases & cost decreases when cost decreases & is zero when output is zero. It is also called
as prime cost. Example: Running expenses like cost of raw material, fuel, temporary labour etc.
Output TVC ( Rs) MC
0 0 -
1 4 4
2 7 3
3 9 2
4 12 3
5 16 4
6 21 5
Curve:
Table shows that TVC is zero at zero level of output
Curve starts from origin – as cost is zero at zero level of
output
TVC is reverse ‘S’ shaped curve

Initially it increases at diminishing rate ( from O to A –

up to 3 level of output ) due to increasing returns to
factor / MC falls.

After A point ( output level 4, 5 & 6) it increases at

increasing rate due to diminishing returns to
factor/increasing MC.

TOTAL COST (TC) :- Total expenditure incurred by a firm for obtaining factors of production required for
production of a commodity. Total Cost (TC) of production is the sum of Total Fixed Cost (TFC) & Total
Variable Cost (TVC). Symbolically TC = TFC + TVC

TC schedule :
Units of output TFC TVC TC = TFC + TVC
0 10 0 10
1 10 4 14
2 10 7 17
3 10 9 19
4 10 12 22
5 10 16 26
6 10 21 31

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 Line horizontal to x axis is TFC.

TVC is inverse ‘S’ shaped curve starting from origin

TC is also inverse ‘S’ shaped curve staring from

level of TFC.

Change in TC is due to change in TVC as TFC is

fixed.

Vertical distance between TC & TVC is TFC

As TC = TFC + TVC

AVERAGE FIXED COST (AFC) :- It is defined as fixed cost of producing per unit of the commodity.
It is obtained by dividing TFC by the level of output. Symbolically-
AFC = TFC / No. of units produced
AFC = TFC / Q
AFC Schedule:
Units of output TFC AFC
1 10 10
2 10 5
3 10 3.3
4 10 2.5
5 10 2
AFC CURVE

AFC is derived from TFC which is constant. When it

is divided by increasing number of output, AFC falls
continuously. In fact it is rectangular hyperbola.

AVERAGE VARIABLE COST (AVC) :- AVC is defined as the variable cost of producing per unit of
commodity. It is obtained by dividing TVC by the level of output. Symbolically:-
AVC = TVC / output OR
AVC = TVC / Q

Explanation by Schedule & Curve:-

Output TVC ( Rs) AVC =

TVC/Q
1 10 10
2 18 9
3 30 10
4 45 11.3

Curve:-

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 AVC is ‘U’ shaped curve.
Initially AVC falls as TVC increases at diminishing
rate due to increasing returns. Increasing returns is
also called as diminishing cost.

At output Q AVC is minimum

After Q it starts increasing due to the fact that TVC

increases at increasing rate due to diminishing
returns. Diminishing returns is also called as
increasing cost.
AVARAGE TOTAL COST ( AVERAGE COST) ( ATC / AC) :- AC is defined as cost of producing per
unit of the commodity. It is obtained by dividing TC by level of output. Symbolically;-
Q = Output
It is also displayed as AC = AFC + AVC
Curve is also ‘U’ shaped curve
MARGINAL COST :- Addition made to the total variable cost or total cost when one more unit of output is
produced. In other words MC is the cost of producing one additional unit of output. Symbolically:
MC = OR MC = …………….. (1)
Alternatively

MC = TVC n – TVC n -1 OR MC = TC n – TC n -1 ………………(2)

Also
∑ MC = TVC ………………..(3)
MC Curve is also ‘U’ Shaped Curve due to law of variable proportions.
AC, AVC, AFC & MC CURVES :-
AFC is downward sloping curve –
rectangular hyperbola.
AC, AVC & MC curves are ‘U’ Shaped
AVC can start below AFC as TVC starts
from below TFC.
AC = AFC + AVC, so AC is above AVC
& AFC
Gap between AC & AVC reduces with
the increase in output, as AFC falls which
shows the difference Between AVC &
AC.

Minimum point of AC is towards right

side of minimum point of AVC
MC cuts AVC & AC from its minimum
point.
RELATIONSHIP:-Between AC & AVC :-
i) AVC is a part of AC since AC = AFC + AVC, therefore AC is above AVC.
ii) AVC & AC are ‘U’ Shaped curves due to law of variable proportions
iii) The difference between AC & AVC decreases with rise in the level of output because AC includes
AFC & AFC falls continuously.
iv) AVC & AC never meets as AFC is rectangular hyperbola which never touches x axis.
v) Minimum point of AC is always towards the right side of minimum point of AVC.
vi) MC curve always cuts AC & AVC from its minimum points.

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Relationship Between TVC & MC :-MC curve is derived from TVC & relationship is ∑ MC = TVC
Output TVC = ∑ MC MC
0 0 -
1 4 4
2 7 3
3 9 2
4 12 3
5 16 4
6 21 5
MC curve is ‘U’ Shaped.

Initially TVC increases at diminishing rate from O to

A due to law of variable proportions & leading to
Falling MC i.e. up to Point B.
After point A TVC increases at increasing rate
which leads to increasing MC after point B.

Relationship between AC/AVC & MC:-

AC/AVC & MC are ‘U’ Shaped curve reflecting law of variable proportions.
1. When MC is less than AC/AVC than AC/AVC tends to fall.
2. When MC is equal to AC/AVC than AC/AVC is minimum.
3. When MC is more than AC/AVC than AC/AVC tends to increase

OPPORTUNITY COST : is the cost of next best alternative foregone / sacrificed. Opportunity costs are the
cost which are incurred on the factors of production. It shows the minimum supply price of a factor.
HOTS
1. Why AFC curve never touches “x‟ axis though lies very close to x axis?
Ans :- Because TFC can never be zero.
2. Why AVC and AFC always lie below AC?
Ans:- AC is the summation of AVC & AFC so AC always lies above AVC & AFC.
3. Why TVC curve start from origin?
Ans:- TVC is zero at zero level of output.
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4. When TVC is zero at zero level of output, what happens to TFC or Why TFC is not zero at zero level of
output?
Ans:- Fixed cost are to be incurred even at zero level of output.
5. Marginal cost includes both fixed cost and variable cost. Comment.
No, marginal cost is only variable cost; it does not include fixed cost. Because, marginal cost is additional
cost and additional cost cannot be fixed cost.
6. ATC must fall simply because AFC always falls. Comment.
No, it is not correct. ATC = AFC +AVC. Being a component of ATC, falling AFC implies falling ATC. But
this is true only in the initial stages of production when average fixed cost is a significant component of AC.
In the later stages of production, average fixed cost (because it is continuously falling) reduces to an
insignificant component of AC. Accordingly AC tends to rise in assonance with rising AVC, even when
AFC tends to fall.
7. TC is not the sum total of marginal cost. Why?
MC is additional cost. Additional cost can only be variable cost. Accordingly sum total of marginal cost will
be total variable cost, not total cost (which includes both variable cost and fixed cost). (Here, MC =
Marginal Cost, TVC = Total Variable Cost, TC = Total Cost.)
These costs remain fixed whatever may be the scale of output. These costs are present even when the output
is zero. These costs are present in short run but disappear in the long run.

Relationship Between MC and AC

The relationship between marginal cost and average cost is an arithmetic relationship. To understand
this relationship let us take a numerical example.
The table A shows the marginal costs, total costs and average costs at different levels of output.
Table A : Cost Schedule
Units TC AC MC
1 60 60
2 110 50 55
3 162 52 54
4 216 54 54
5 275 59 55
Column 1 shows the level of output.
Column 2 shows the total cost of producing different levels of output.
Column 3 shows the increase in total cost resulting from the production of one more unit of output.
(It is called marginal cost. Thus MCn = TCn - TCn-1, where n and n-1 are levels of output).
Column 4 shows the average cost at different levels of output (ACn = TCn/q )
This table shows that:
1. Average cost falls only when marginal cost is less than average cost. Upto the third unit ofoutput, the
marginal cost is less than the average cost and average cost is falling. When 2 units are produced the
marginal cost is Rs. 50 which is less than the previous average cost (Rs.60), now average cost falls from Rs.
60 to Rs. 55. When 3 units are produced, the marginal cost is Rs. 52 which is less than the average cost of 2
units (Rs. 55) so once again the average cost falls from Rs. 55 to Rs. 54.
2. Average cost will be constant when marginal cost is equal to average cost. When 4 units are produced,
average cost does not change (it is Rs. 54 when 3 units are produced and remains Rs. 54 when 4 units are
produced) because marginal cost (Rs. 54) is equal to average cost (Rs. 54).
3. Average cost will rise when marginal cost is greater than average cost. When 5 units are produced average
cost rises from Rs. 54 to Rs. 55, because the marginal cost (Rs. 59) is greater than the average cost (Rs. 54).
This relationship between marginal cost and average cost is a generalized relationship and holds
good in case of the marginal and average values of any variable, be it revenue or product etc. In the box a
simple proof of the relationship is given: This is for reference only
REVENUE
Revenue:- Money received by a firm from the sale of given output in the market.
Total Revenue (TR): Total sale receipts or receipts from the sale of given output.
TR = Quantity sold × Price (or) output sold × price OR TR = Q x P
Average Revenue (AR): Revenue or Receipt received per unit of output sold.
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AR = TR / Output sold
AR and price are the same.
TR = Quantity sold × price or TR = Q x P
AR =

AR = Putting the value of TR

AR= price
AR and demand curve are the same.
Shows the various quantities demanded at various prices.
Marginal Revenue (MR): Additional revenue earned by the seller by selling an additional unit of output.
MRn = TR n - TR n-1 OR MR n = Δ TR n / Δ Q
TR = Σ MR
Relationship between TR & MR
 When MR increases TR increases at increasing rate,
 When MR decreases TR increases at decreasing rate, When MR is negative TR falls, Relationship
between AR & MR
 AR also increases till MR > AR.
 AR is constant & maximum when MR=AR
 When MR is zero TR is maximum.
 AR falls when MR< AR

The diagram shows that till point A MR increases &

TR increases at increasing rate
After point A MR falls, so TR increases at
decreasing rate.
At point B MR is zero TR is maximum at B’
After point B MR is negative & TR falls

FIRMS REVENUE (DEMAND) CURVES

i) When Price is constant :- When Price is constant MR is also constant , TR increases at
constant rate because TR = ∑ MR i.e. MR indicates the rate at which TR increases.
Relationship can be studied as under:
Quantity of Output Price Per Unit ( TR ( Q x P) MR = Δ TR / Δ
(Q) P) Q
1 10 10 10
2 10 20 10
3 10 30 10
4 10 40 10
5 10 50 10
6 10 60 10
7 10 70 10

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 Constant price means constant MR & TR
increases at constant rate. AR = MR = Price
As Under Perfect Competition.

TR is shown by a straight line moving upward.

It starts from the origin because TR is zero when
output is zero.

THEORY OF SUPPLY
Meaning of supply
Supply means the quantity of a commodity which a firm or an industry is willing to sell at a particular price,
during period of time.
Law of supply
This law states that 'other things remaining the same', an increase in the price of a commodity leads to an
increase in its quantity supplied. Thus, more of a commodity is supplied at higher prices than at lower
prices. This law can be explained with the help of a supply schedule and curve.
A supply schedule is a table which shows the quantities of a commodity supplied at various prices during a
given time period.

Supply Schedule Supply Curve

Price ( Rs) Supply ( Units)
1 100
2 200
3 300
As the price increases from Re. 1 to Rs. 3, the supply also rises from 100 units to 300 units, in response to
the rising price. What is the basis of the law of supply? Other things remaining the same,
an increase in price results in higher profits for the producer. The higher the price of the commodity,
the greater are the profits earned by the firms and the greater is the incentive to produce more.
Similarly when the price falls, profits decline, resulting in a decrease in quantity supplied of the
commodity. Thus the price and quantity supplied of a commodity are directly related, other things
remaining the same.
SS is Supply curve – Positively sloped
Because when price rises from op to op1 quantity
supplied also increases from oq to oq1. Direct
relationship between Price & supply.

ASSUMPTIONS OF LAW OF SUPPLY:-

i) No change in price of factors & Price of related goods
ii) No change in technique of production
iii) No change in goal of firm
iv) Government policy does not change
v) Indirect taxed remain constant
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MARKET SUPPLY:-It refers to quantity of a commodity that all the firms are willing and able to offer for
sale at each possible price during a given period of time.
Market supply schedule: - Sum of the total production of firms producing a commodity is market supply. It
is the supply of all the firms i.e. supply schedule of industry as a whole. Suppose there are two firms, supply
schedule is as follows:-
Price ( Rs) Individual Individual Market Supply
supply of supply of (A+ B)
Firm A Firm B
1 0 5 5
2 5 10 15
3 10 15 25
4 15 20 35
5 20 25 45

FACTORS AFFECTING THE SUPPLY OF A COMMODITY:

1. Price of Commodity: Higher the price of a commodity, larger is the quantity supplied and vice-versa.
2. Technological Changes: Improved techniques reduce the cost of production and increase the supply and
vice versa.
2. Input Prices: A fall in prices of factors of production will increase the supply of the commodity and vice-
versa.
3. Goal of the firm: If the goal is profit maximization, more quantity will be supplied at higher price. If the
goal is sales maximization more will be supplied at same price. If its aim is to minimize risk, less will be
supplied.
4. Price of Related Goods: If price of a substitute goods increase, supply of the commodity concerned will
fall. If price of a complementary good increases, supply of the commodity concerned increases.
5. Expectation about future prices: If there is an expectation of increase in price of the commodity in
future, supply will be less at present and vice-versa.
6. Government Policy: Imposition of taxes reduces supply and subsidy increases supply.
7. Number of firm: The larger the number of firms, greater in the market supply and vice-versa
‘CHANGE IN SUPPLY’ VERSUS ‘CHANGE IN QUANTITY SUPPLIED’
(‘shift of supply curve’ versus ‘movement along a supply curve’) The supply of a commodity depends on its
own price and 'other factors' like input prices, technique of production, prices of other goods, goals of the
firm, taxes on the commodity etc.
Movement along a supply curve (change in quantity supplied)
The law of supply states the effect of a change in the own price of a commodity on its supply, other
things remaining constant. The supply curve also carries the same assumption. Thus when other factors
influencing supply do not change, and only the own price of the commodity changes, the change in supply
takes place along the curve only. This is what movement along a supply curve means. A movement from
one point to another on the same supply curve is also referred to as a “change in quantity supplied”.
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It is Expansion & Contraction
i) EXPANSION IN SUPPLY:-When price rises & quantity of commodity is supplied more, the
supplier moves rightwards on the same supply curve. Other factors affecting supply remain
constant. This is called as expansion in supply curve.
In figure OQo is the quantity supplied at price
OPo. When the price rises to
OP1 the quantity supplied increases to OQ1.
Thus there is a rightward movement along
the supply curve from point A to B. It is
extension of supply.

Due to rise in price when other factors

affecting supply remain constant

ii) CONTRACTION IN SUPPLY:- When price falls ,quantity of commodity supplied reduces, the
supplier moves leftwards on the same supply curve. Other factors affecting supply remain
constant. This is called as contraction in supply curve.

In figure OQ1 is the quantity supplied at

price OP1. When the price falls to
OP0 the quantity supplied also falls to OQ0.
Thus there is a leftward movement along the
supply curve from point B to A.
It is Contraction of supply.

Due to fall in price when other factors

affecting supply remain constant

SHIFTS OF THE SUPPLY CURVE (CHANGE IN SUPPLY)

When supply changes due to changes in factors other than the own price of the commodity, it results
in a shift of the supply curve. This is also referred to as a “change in supply”. It is increases & decrease
in supply.
i) INCREASE IN SUPPLY:- An ‘increase’ in supply means more of the commodity is supplied at
same price. As a result the supply curve shifts to the right. It is due to
 Fall in input price
 Technological improvement
 Fall in indirect taxes
 Fall in price of other factors affecting supply

Supply ‘increases’ the supply curves SS shifts

to the right S’S’. The market is now
willing to supply more i.e. OQ1, at the same
price OP.

‘DECREASE’ IN SUPPLY means less of the commodity is supplied at the same price. As a result, the
supply curve shifts inwards to the left.‘Decrease’ in supply of a good can be caused by a change in any one
or more of the 'other factors' affecting supply, own price remaining unchanged. For example, if the input
prices rise or there is an increase in the prices of other related commodities, the producers supply less at the
same price resulting in a leftward shift of the supply curve.

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 Figure at price OP, previously OQ1 units were
supplied at S1 supply curve.
Which decreased to OQ2. It means that the market is
now willing to supply less at the same price OP.
Thus Supply curve shifts towards left to S2.

ELASTICITY OF SUPPLY:-Price Elasticity of Supply measures the degree of responsiveness of change

in Supply by change in price of the good. Law of Supply measures direction of relationship between price &
Supply where as elasticity measures the proportional change in Supply by change in price.
Ed = Proportional (%) change in Supply / Proportional ( %) change in price x 100
Ed = ∆q/q x100 / ∆p/p x100 OR Ed = ∆q /q x p/∆p
TYPES OF ELASTICITY OF SUPPLY:-
6. Perfectly Elastic Supply:-When Supply of a commodity
rises or falls to any extent without any change in price, the
Supply for the commodity is said to be perfectly elastic. It
is an imaginary situation
Price Supply
5 10
5 20
5 30
Diagram & Schedule shows that Supply changes without change
in price & curve becomes horizontal to x axis.
7. Highly Elastic Supply ( Ed>1) :- When change in price
leads to more proportional change in Supply, the Supply is
said to be highly elastic. If the supply curve is extended to
the left it will touch y axis.
Price Supply
7 20
5 10
When price falls by Rs 2/- Supply falls by 10 units. The
coefficient of elasticity of Supply is greater that unity.

8. Unitary Elastic Supply ( Ed = 1) :- When Proportional

Change in Supply is equal to proportional change in price,
the Supply is said to be unitary elastic. If supply curve is
extended towards left it will touch origin.
Price Supply
7 12
5 10
Supply curve is a straight upwards sloping line from
origin.
9. Inelastic Supply ( Ed< 1) :- When Proportional change in
Supply is less than proportional change in price, the Supply is
said to be inelastic Supply. If supply curve is extended towards
left it will touch x axis.
Price Supply
20 12
10 10
Where Supply changes less with the change in price. (pp1 >
qq1)

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 10. Perfectly Inelastic Supply ( Ed = 0):- When the Supply
for the commodity does not change as a result of change in
its price, Supply is said to be perfectly in elastic.
Price Supply
7 10
5 10

MEASURING ELASTICITY OF SUPPLY:-

PERCENTAGE METHOD:- elasticity of Supply is measured by the ratio of proportional change in

Supply & proportional change in price. Symbolically

Ed = Proportional (%) change in Supply / Proportional (%) change in price x 100

Ed = ∆q/q x100 / ∆p/p x100
OR Ed = ∆q /q x p/∆p
The absolute value of elasticity of Supply ranges from zero to infinity

PRODUCER’S EQUILIBRIUM: MC = MR APPROACH

Producer’s equilibrium refers to the level of output of a commodity which gives the maximum profit to
the producer of that commodity. Profit equals total revenue less total cost. Therefore, the output level
at which ‘total revenue less total cost’ is maximum is called the equilibrium output level.
MC = MR approach : MC = MR approach is the way of identifying producer’s equilibrium. The two
conditions of MC = MR approach are:
(i) MC = MR
(ii) MC is greater than MR after the MC = MR output level.

For a producer to be in equilibrium it is necessary that MC equals MR as well MC becomes greater than MR
if more output is produced. When MC is equal to MR, the benefit is equal to cost, the producer is in
equilibrium subject to that MC becomes greater than MR beyond this level of output. If MC is increasing,
now the producer will stop increasing the output, so this is the equilibrium situation.
Explanation with the help of schedule:
Units of output MR MC
1 12 15
2 12 12
3 12 10
4 12 8
5 12 7
6 12 9
7 12 10
8 12 12
9 12 15
In the above schedule MC = MR condition is fulfilled at 2 & 8 levels of output, but consumer will be at
equilibrium as MC is increasing at 8 level of output. Thus consumer is at equilibrium when producer
produces 8 units of output.
Graphic Presentation

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Note that in the above curve MC = MR condition is satisfied both at A & e both level of output (oq1&oq)
But the second condition – MC becomes greater than MR – is satisfied only at OQ i.e. point e. Therefore
equilibrium output level is OQ units.
THREE DISEQUILIBRIUM SITUATIONS
(1) MR > MC, it is profitable to produce more. Therefore, so long as MR is greater than MC, the maximum
profit level, or the equilibrium level is not reached. (Q1 to Q in the above diagram)
The equilibrium is not achieved because it is possible to add to profits by producing more.
(2)MC > MR & MC is falling; The producer is also not in equilibrium when MR is less than MC because
benefit is less than the cost. Therefore, for equilibrium to reach it is a necessary condition (but not sufficient)
that MC equals MR. MC is falling, so there is scope for earning more profit, he will not increase production.
(3) MC > MR after MC = MR output level
‘MC = MR’ is a necessary condition but not sufficient enough to ensure equilibrium. It is because the
producer may face more than one MC =MR outputs ( at A and e ). But out of these only that output beyond
which MC becomes greater than MR is the equilibrium output. It is because if MC is greater than MR,
producing beyond MC = MR output will reduce profits, it is no longer possible to add to profits the
maximum profit level is reached.

PRODUCER’S EQUILIBRIUM WHEN PRICE IS NOT CONSTANT: When a producer can sell more
only by lowering the price, the MR curve is downward sloping. The typical MC Curve is U-shaped.

Note that MC = MR condition is satisfied at both A and e. But the second condition – MC is greater
than MR or MC curve cuts MR from below – is satisfied only at e. So, the equilibrium level of output
is OQ.Two conditions may also exist
i) MR> MC At output level less than OQ, MR> MC which implies that firm is earning profit on the
last unit of output. The marginal profit provides an incentive to the firm to increase production
and move towards OQ units of output. Thus If MR> MC firm increases output to maximise
profit.
ii) MR< MC At output level more than OQ, MR< MC which implies that firm is making loss on the last
unit of output. Hence in order to maximise profit, a rational producer decrease production as long
as MC > MR. Thus If MR< MC firm moves towards producing OQ units of output.

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