MB0042-Managerial Economics Unit-5 Production Analysis

Program

: MBA

Semester
Subject Code Subject Name Unit Number Unit Title

:I
: MB0042 : Managerial Economics :5 : Production Analysis

Confide ntial NEXT HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production Analysis

Objectives:
To explain concept of production, production function and its managerial uses.

To define meaning and different cost concepts and managerial uses of cost of
production.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Lecture Outline

Introduction Meaning of Production and Production Function

Cost of Production
Summary Check Your Learning Activity

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Introduction

A business firm is also called as a production unit. Production is one of the most important activities of a firm in the circle of

economic activity.
The main objective of production is to satisfy the demand for different kinds of goods and services of the community.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Production means transformation of physical Inputs into physical Outputs.

Inputs
land, labor, capital organization.

Transformation Process

Outputs
finished products

Entry into Firms

Exit of Firms

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Production Function :
Expresses the technological relationship between physical quantity of inputs employed and physical quantity of outputs obtained by a firm during a specified period of time. Q = f (L, N, K.etc) where Q =output per unit of time and L N K etc =inputs Rate of output Q is a function of inputs employed by firm per unit of time.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Factor inputs are of two types :

Fixed Inputs : factors, quantity of which remains constant irrespective of the level of output produced by a firm. Eg. land, buildings, machines, etc.

Variable inputs : factors, quantity of which varies with variations in the levels of
output produced by a firm. Eg. raw materials, fuel, etc.

Short run : is a period of time in which only variable factors can be varied while fixed factors like plants, machineries, etc remain constant.

Long run : is a period of time where producer have adequate time to make any
sort of changes in the factor combinations.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Types of production functions :

Short Run Production Function : fixed factors constant and change only a few variable factor inputs. All factor inputs are constant and only one variable input varies. Eg. Law of Variable Proportions. All factor inputs are constant and only two variable inputs varies. Eg. Iso-Quants and Iso-Cost curves. Long Run Production Function All factor inputs, returns to scale. fixed and variable vary in same proportion. Eg. The laws of

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Production Function with One Variable Input Case :

The Law of Variable Proportions : An increase in the quantity of a variable factor added to fixed factors, results in a less than proportionate increase in the amount of product, given technical conditions. Production function with Two Variable Inputs ISO-Quants and ISO-Costs IsoQuant curve represents all possible combinations of two factor inputs which are capable of producing the same level of output
Combination s A B C Factor X (Labor) 12 8 5 Factor Y Capital 1 2 3 Total Output in units 100 100 100

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Each IsoQuant curve represents only one particular level of output. IsoQuant Map :a number of Iso-Quants representing different amount of out put.
Factor X Capital Y

3000 2000 1000 IQ1

IQ3 IQ2 X

0 Factor Y Labor

Marginal Rate of Technical Substitution (MRTS) : the rate at which a factor of production can be substituted for another at the margin without affecting any change in the quantity of output.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

ISO-Cost Line or Curve :

It indicates the different combinations of the two inputs which the firm can purchase at given prices with a given outlay.

Producers Equilibrium (Optimum factor combination or least cost combination).

The position of equilibrium is indicated at the point where Iso-Quant curve is tangential to Iso-Cost line. (See graph)
Y M E1 A 25 Units Factor X R

E2

Point of equilibrium IQ
X

B N 50 Units Factor Y

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Long Run Production Function (change in all factor inputs in same

proportion) Laws of Returns to Scale : all necessary factor inputs are increased or decreased to the same extent so that whatever the scale of production, the proportion among the factors remains the same. Phases of Returns to Scale : when quantity of inputs are increased in same proportion, returns to scale may be either more than equal, equal or less than

equal.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Increasing Returns to Scale : When quantity of all factor inputs are increased in a given proportion and output increases more than proportionately.

Constant Returns to Scale : When output increases in same proportion. Diminishing Returns to Scale : When output increases less than

proportionately.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Economies of Scale : benefits that accrue to a firm as a result of increase in its

scale of production. Internal Economies or Real Economies : economies which arise because of the actions of an individual firm to economize its cost. Economies of Scope : those benefits which arise to a firm when it produces more than one product jointly rather than producing two items separately by two different business units.

SC

C [Q1] C [ Q2] - C [ Q1and Q2] C [Q1 and Q2]

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Production & Production Function

Diseconomies of Scope : disadvantages which occur when cost of producing two products jointly are costlier than producing them individually.

Difference between Economies of Scale and Economies of Scope:

Economies of scale 1. It is connected with increase or decrease in scale of production 2. It shows change in output of a single product 3. it is associated with supply side changes in output. 4. It indicates savings in cost owing to increase in volume of output Economies of scope 1. It is connected with increase or decrease in distribution & marketing. 2. It shows a change in output of more than one products. 3. It is associated with demand side changes in output 4. It indicates savings in cost due to production of more than one product.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Cost of Production

Cost of production refers to the total money expenses (Both explicit and implicit) incurred by the producer in the process of transforming inputs into outputs

Variables of Cost function :

Production function : If a firm is able to produce higher output with little quantity of inputs, the cost function becomes cheaper and vice-versa. The market prices of inputs : If market prices of different factor inputs are high , cost function becomes higher and vice-versa. Period of time : Cost function becomes cheaper in long run and it would be relatively costlier in short run.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Cost of Production

Types of cost function :

Short run cost function. Long run cost function.

Cost-Output Relationship in the Short-Run :

The cost-output relationship in the short run refers to a particular set of conditions where the scale of operation is limited by the fixed plant and equipment. Hence, the costs of the firm in the short run are divided into fixed cost and variable costs. A cost-schedule is a statement of a variation in costs resulting from variations in the levels of output. It shows the response of cost to changes in output.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Cost of Production

Total fixed cost (TFC) : total money expenses incurred on fixed inputs in the short run. TFC = TC - TVC.

Total variable cost (TVC) : total money expenses incurred on the variable factor

inputs in the short run. TVC = TC-TFC. TVC = f (Q)

Total cost (TC) : aggregate money expenditure incurred by a firm to produce a given quantity of output. TC = TFC +TVC.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Cost of Production

Average fixed cost (AFC) : is the fixed cost per unit of output. AFC = TFC/Q Average variable cost: (AVC) : is variable cost per unit of output. AVC can be computed by dividing the TVC by total units of output. AVC = TVC/Q.

Average cost (AC) : cost per unit of output. AC = TC/Q

Marginal Cost (MC) : additional cost incurred to produce an additional unit. MC = TC / TQ. Where TC change in TC and TQ change in total output.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Cost of Production

Cost Output Relationship in the Long Run :

Distinction between fixed and variables costs in total cost of production will disappear in long run. In long run only average total cost is considered.

Long run average cost is the long run total cost divided by the level of output.
The long run costoutput relationship is explained by drawing a long run cost curve through short run curves.
Cost of Production

Y
LAC SAC 1 SAC 2 SAC 3 SAC 4 SAC 5

Output

X Q

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Cost of Production

Long Run Marginal cost :

A long-run marginal cost curve can be derived from the long-run average cost curve. Just as the SMC is related to the SAC, similarly the LMC is related to the LAC

and, therefore, we can derive the LMC directly from the LAC.
Y
LMC SMC 3 E LAC

C o st of P ro d u ct io n

SMC 1 SAC 1 A

SAC 3

SMC 2 SAC 2

Output

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Summary

Production in economics implies transformation of inputs into outputs for our final consumption.

Production function explains the quantitative relationship between the amounts of inputs used to get a particular physical quantity of outputs.

Cost function explains the relationship between the amounts of costs to be incurred to produce a particular quantity of output.

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Check Your Learning

1. Production function explain ___ relationship between inputs and outputs. Ans. Technological 2. In the short period only ___________ factor inputs are changed. Ans. Variable 3. Internal economies depend on the growth of a ___ and external economies depend on the growth of the ____. Ans. Firms, industry 4. In the long run all cost are ______________. Ans. Variable

Confide ntial NEXT PREV HOME

MB0042-Managerial Economics Unit-5 Production Analysis

Activity

Go to a local manufacturer producing goods for local consumption like tin boxes, baskets etc and find out how the manufacturer ascertains the market

price

for

his

product

after

taking

into

consideration

the

costs

of

manufacturing.

Confidential PREV HOME