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CHAPTER 3

PRODUCTION AND COST

I Choose the correct answer

1. The formula of production function is

a) q=f (L, K) c) Y=f(x)
b) q=d(p) d) None of the above.
Ans: (a) q=f (L, K)

2. In the short run, a firm

a) Can change all the inputs c) can keep inputs fixed
b) Cannot vary all the inputs d) None of the above
Ans: (b) Cannot vary all the inputs

3. The change in output per unit of the change in the input is called
a) Marginal product c) Total product
b) Average Product d) Product
Ans: (a) Marginal product

4. Cobb-Douglas production function is

a) q= (x, x) c) q= (x1α, x2β)
b) q= (x1, x2) d) q= (0)
Ans: c) q= (x1α, x2β)

5. TC=
a) TVC c) TFC+TVC
b) TFC d) AC + MC
Ans: c) TFC+TVC

II Fill the blanks:

1. In the long run, all inputs are ……………
Ans: Varied
2. ………….is defined as the output per unit of variable input.
Ans: Average Product
3. Marginal product and average product curves are …………in shape.
Ans: Inverse U
4. SMC curves cuts the AVC curve at the …………point of AVC curve from below.
Ans: Minimum
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5. …………….is the set of all possible combinations of the two inputs that yield the same
maximum possible level of output.
Ans: Isoquant
III Match the following:

A B
1. CRS a) ΔTC/Δq
2. SAC b) Long run Average cost
3. LRAC c) Short run Average cost
4. TFC+TVC= d) Constant returns to scale
5. SMC e) TC

Ans:

A B

1. CRS d) Constant Returns to Scale

2. SAC c) Short Run Average Cost

3. LRAC b) Long run Average Cost

4. TFC + TVC = e) TC

5. SMC a) ΔTC/Δq

IV Answer the following questions in a sentence or a word:

1. What do you mean by total product?

Ans: Total product is the relationship between a variable input and output when all other
inputs are held constant.
2. What is Average product?
Ans: Average Product is defined as the output per unit of variable input. We calculate it as
APL=TPL/L.
3. Give the meaning of marginal product.
Ans: Marginal Product of an input is defined as the change in output per unit of change in the
input when all other inputs are held constant. Or
It is the additional unit of output per additional unit of variable input. It is calculated by
dividing the change in output by change in input (labour).
MPL = ∆TPL/∆L.
4. Write the meaning of cost function of the firm.
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Ans: The cost function of the firm describes the least cost of producing each level of output,
given prices of factors of production and technology. It deals with the output and prices of
factors of production.
5. What is total fixed cost?
Ans: The cost that a firm incurs to employ fixed factors of production (inputs) is called as
Total Fixed Cost. Or
It is the cost that does not change with the change in the level of output.
6. What is average fixed cost?
Ans: Average fixed cost is the cost per unit of fixed input. Or
It is the fixed cost of producing one unit of a good.
AFC = TFC/q.

V Answer the following questions in four sentences:

1. What is Isoquant?
Ans: An isoquant is the set of all possible combinations of the two inputs that yield the same
maximum possible level of output. Each isoquant represents a particular level of output and is
labelled with that amount of output. It is just an alternative way of representing the
production function.
2. Give the meaning of the concepts of short run and long run.
Ans: The concepts of short run and long run are defined as a period simply by looking at
whether all the inputs can be varied or not. It is not advisable to define short run and long-
run in terms of days, months or years.
In the short run, at least one of the factors – labour or capital cannot be varied and
therefore, remains fixed. In order to vary the output level, the firm can vary only the other
factor. The factor that remains fixed is called the fixed factor and the other factor which the
firm can vary is called the variable factor.
In the long run, all factors of production can be varied. A firm in order to produce
different levels of output in the long run may vary both the inputs simultaneously. So, in the
long there is no fixed factor.
3. Mention the types of returns to scale.
Ans: The types of returns to scale are:
(a) Constant Returns to Scale
(b) Increasing Returns to Scale
(c) Decreasing Returns to Scale
4. Name the short run costs.
Ans: The short run costs are: Total Fixed cost, Total Variable cost, Total Cost, Average Fixed
Cost, Average Variable Cost, Average Cost and Marginal Cost.
5. What are long costs?
Ans: There are two long run costs namely:
(a) Long run Average Cost (LRAC): It is the cost per unit of output in the long run.
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(b) Long run Marginal Cost (LRMC): It is the cost of producing an additional unit in the long
run.

VI Answer the following questions in 12 sentences.

1. Explain isoquant with the help of a diagram.

Ans: An isoquant is the set of all possible combinations of the two inputs that yield the same
maximum possible level of output. Each isoquant represents a particular level of output and is
labelled with that amount of output. It is just an alternative way of representing the
production function.
The concept of isoquant can be explained with the help of following diagram:

O L1 L2 L3 Labour X
The above diagram generalizes the concept of isoquant. In the above diagram, labour is
measured in OX axis and Capital is measured in OY axis. There are 3 isoquants for the three
output levels viz., q=q1, q=q2 and q=q3. Two input combinations (L1, K2) and (L2, K1) give us
the same level of output q1. If we fix capital at K1 and increase labour to L3, output increases
and we reach a higher isoquant q=q2. When Marginal products are positive, with greater
amount of one input, the same level of output can be produced only using lesser amount of
the other. Therefore, isoquants curves slope downwards from left to right (negatively sloped).

2. Explain TP, MP and AP with the examples.

Ans: The TP – total product, MP- marginal product and AP – Average Product
Total Product:
Total product is the relationship between a variable input and output when all other inputs
are held constant. Suppose we change a single input and keep all other inputs constant.
Then for different levels of that input, we get different levels of output. This relationship
between the variable input and output, keeping all other inputs constant, is often referred to
as Total Product of the variable input.
TPL= ∑ MPL
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Average product:
Average Product is defined as the output per unit of variable input. We calculate it as
APL=TPL/L
where APL is the Average Product of Labour, TPL is the Total product of labour and L
is the amount of labour input used.
Marginal Product:
Marginal Product of an input is defined as the change in output per unit of change in the
input when all other inputs are held constant. It is the additional unit of output per additional
unit of variable input. It is calculated by dividing the change in output by change in input-
labour.
MPL = ∆TPL/∆L.
The concepts of TP, AP and MP can be explained with the help of following table:

Labour TP MPL APL

0 0 - -
1 10 10 10
2 24 14 12
3 40 16 13.33
4 50 10 12.5 11.2
5 56 6 9.5
6 57 1
The above table shows the total product, Marginal product and Average product of
labour. The third column gives us a numerical example of Marginal product of labour. The
values in this column are obtained by dividing change in TP by change in Labour. The last
column gives us a numerical example of average product of labour. The values in their
column are obtained by dividing TP by Labour.
3. Write a brief note on returns to scale.
Ans: The law of returns to scale says that when a producer increases all the inputs in the same
proportion, he initially experiences the stage of increasing returns to scale, then constant
returns to scale and finally diminishing returns to scale. This is called as the law of returns to
scale. This is a long-run production function.
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• Increasing returns to scale: When proportional increase in all inputs results in an

increase in output by a larger proportion, the production function is said to display
increasing returns to scale.
• Constant returns to scale: When a proportional increase in all inputs results in an
increase in output by the same proportion, the production function is said display
constant returns to scale.
• Decreasing returns to scale: When a proportional increase in all inputs results in an
increase in output by a smaller proportion, the production function is said to display
decreasing returns to scale.
For example, if in a production process, all inputs get doubled. As a result, if the
output gets doubled, the production function exhibits constant returns to scale, if
output is less than doubled, exhibits decreasing returns to scale and if is more than
doubled, exhibits increasing returns to scale.
4. Explain the long run costs.
Ans: In the long run, all inputs are variable. There are no fixed costs, The total cost and the
total variable cost coincide in the long run. There are two types of long run costs. They are as
follows:
a) Long Run Average Cost (LRAC): The long run average cost is the cost per unit of
output produced. It is obtained by dividing the Total Cost by the output produced. It can
be calculated as follows: LRAC = TC/q
Where TC is Total cost and ‘q’ is quantity of output produced.
b) Long Run Marginal Cost: The long run marginal cost is the change in total cost per unit
of change in output. When output changes in discrete units, then, if we increase
production from q1-1 to q1 units of output, the marginal cost of producing q1th unit will be
measured as follows:
LRMC = (TC at q1 units) – (TC at q1-1 units) or
LRMC = TCn – TCn-1
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5. The following table gives the TP schedule of labour. Find the corresponding Average
product and marginal product schedules
TPL 0 15 35 50 40 48
L 0 1 2 3 4 5
Ans: Calculation of Average Product (AP) and Marginal Product (MP).
AP is obtained by dividing TPL by Labour (L): APL = TP/L
MP is obtained from TPL with the help of formula: MPL = TCn – TCn-1

TPL L APL MPL

0 0 0 -
15 1 15 15
35 2 17.5 20
50 3 16.66 15
40 4 10 -10
48 5 9.6 8

VII Answer the following questions in 20 sentences:

1. Explain the various short run costs.

Ans: The various short run costs are Total Cost, Total Fixed Cost, Total Variable Cost, Average
Cost, Average Fixed Cost, Average Variable Cost, and Marginal Cost. The following table
shows the various types of short run costs:

Output TFC TVC TC AFC AVC AC MC

(Q)
0 100 0 100 - - - -

1 100 150 250 100 150 250 150

2 100 260 360 50 130 180 110

a) Total Fixed Cost (TFC):

It refers to the total money expenses incurred on all the fixed factors in the short run. TFC remains
constant at all levels of output. Therefore, the TFC is horizontal straight line, parallel to OX axis.

TFC = TC-TVC
TFC = AFC x Q
(Where Q is the quantity of the output)
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b) Total Variable Cost (TVC):

It refers to the total money expenses incurred on the variable factor inputs in the short-run. It
increases along with the output & remains zero when the output is zero.
So, the TVC curves starts from the origin, rises gradually in the beginning & then rises sharply in
the end.
TVC = TC-TFC
TVC = AVC x Q
c) Total Cost (TC):
It is the total expenses incurred by the firm on all the factors to produce a given quantity of
output. TC varies in the same proportion as total variable cost because the total fixed cost is
constant. It is parallel to TVC curve. It includes total fixed cost and total variable cost.
TC = TFC + TVC
TC = AC x Q
TC = ∑ MC
d) Average Fixed Cost (AFC):
It is the fixed cost per unit of output. In other words, it is average expenses incurred on a
single unit of output produced. AFC and output are inversely related.
AFC curve will have a negative slope. It is in the shape of a rectangular hyperbola. The
Average Fixed Cost is obtained by dividing Total Fixed Cost by Output.
AFC=TFC/Q
AFC = AC - AVC
e) Average Variable Cost (AVC):
It is a variable cost per unit of output. It can be calculated by dividing total variable
cost by the total units of output.
When this cost is graphically represented, we get a ‘U’ shaped AVC.
AVC=TVC/Output or
AVC=AC-AFC
f) Average Cost (AC): It is the cost per unit of output produced.
It is also ‘U’ shaped curve. It is obtained by dividing total cost by the total output produced i.e.
AC = TC/Q
AC = AFC + AVC
If the AC is graphical represented, we get U shaped curve because of the operation of law of
variable proportions.
g) Marginal Cost (MC or SMC): It is an additional cost incurred to produce an additional unit of
output. In other words, it is the net additions to the total cost when one more unit of output is
produced. Initially the SMC falls, and then after a certain point, it rises. SMC curve is,
therefore, ‘U’-shaped.
MC = TCn-TCn-1 or
MC = ∆TC /∆Q
(Where TCn = Total Cost of ‘n’ units of output and TCn-1 is Total cost of previous output,
∆ represents change.)
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2. Explain the shapes of long run cost curves.

Ans: In the long run, all inputs are variable. There are no fixed costs, The total cost and the
total variable cost coincide in the long run. There are two types of long run costs. They are as
follows:
c) Long Run Average Cost (LRAC): The long run average cost is the cost per unit of
output produced. It is obtained by dividing the Total Cost by the output produced. It can
be calculated as follows: LRAC = TC/q
Where TC is Total cost and ‘q’ is quantity of output produced.
In a typical firm the Increasing Returns to scale is observed at the initial level of
production. This is then followed by the Constant Returns to Scale and then by the
Diminishing Returns to Scale. Accordingly, the LRAC curve is ‘U’ shaped curve. Its
downward sloping part corresponds to Increasing Returns to Scale and upward rising part
corresponds to Decreasing Returns to scale. At the minimum point of the LRAC curve,
Constant returns to scale is observed.
d) Long Run Marginal Cost: The long run marginal cost is the change in total cost per unit
of change in output. When output changes in discrete units, then, if we increase
production from q1-1 to q1 units of output, the marginal cost of producing q1th unit will be
measured as follows:
LRMC = (TC at q1 units) – (TC at q1-1 units) or
LRMC = TCn – TCn-1
For the first unit of output, both LRMC and LRAC are the same. Then, as output
increases, LRAC initially falls, and then, after a certain point, it rises. As long as average cost
is falling, marginal cost must be less than the average cost. When the average cost is rising,
marginal cost must be greater than the average cost. LRMC curve is there a ‘U’ shaped curve.
It cuts the LRAC curve from below at the minimum point of LRAC. The following diagram
shows the shapes of the long run marginal and the long run average cost curves for a typical
firm.

Y LRMC

LRAC
Cost M

X
q1
O Output
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In the above diagram, LRAC reaches its minimum at q1. To the left of q1, LRAC is
falling and LRMC is less than the LRAC curve. To the right of q1, LRAC is rising and LRMC
is higher than LRAC.

3. Explain the shapes of Total Product, Marginal Product and Average Product curves.
Ans: Total Product (TP):
Total product is the relationship between a variable input and output when all other inputs are
held constant. Suppose we vary a single input and keep all other inputs constant. Then for
different levels of that input, we get different levels of output. This relationship between the
variable input and output, keeping all other inputs constant, is often referred to as Total
Product of the variable input.
The total product curve in the input-output plane is a positively sloped curve as
follows:
Y

TPL
Output q1

O Labour
L
The above diagram shows the total product curve for labour. When all other inputs are held
constant, it shows the different output levels obtainable from different units of labour.
Labour is measured in OX axis and output is measured in OY axis. With L units of
labour, the firm can at most produce q1 units of output.
Average product (AP) and Marginal Product (MP):
Average Product is defined as the output per unit of variable input. We calculate it as
APL=TPL/L
where APL is the Average Product of Labour, TPL is the Total product of labour and L is the
amount of labour input used.
Marginal Product of an input is defined as the change in output per unit of change in the
input when all other inputs are held constant. It is the additional unit of output per additional
unit of variable input. It is calculated by dividing the change in output by change in input
labour.
MPL= TPL – TPL-1
MPL = ∆TPL/∆L.
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According to the law of variable proportions, the marginal product of an input initially
rises and then after a certain level of employment, it starts falling. The MP curve therefore,
looks like an inverse ‘U’ shaped curve.
For the first unit of the variable input, one can easily check that the MP and the AP are
same. As the amount of input is increased, the MP rises. AP being the average of marginal
products also rises, but rises less than MP. Then after a point, the MP starts falling. However,
as long as the value of MP remains higher than the value of the AP, the AP continues to rise.
Once MP has fallen sufficiently, its value becomes less than the AP and the AP also starts
falling. So, AP curve is also inverse ‘U’ shaped.
This can be diagrammatically represented as follows:
Y
P

Output
MPL APL

O L Labour X

In the above diagram, MPL is marginal product of labour, APL is the average product labour.
As long as the AP increases, it must be the case that MP is greater than AP. Otherwise, AP
cannot rise. Similarly, when AP falls, MP has to be less than AP. It follows that MP curve
cuts AP curve from above at its maximum. In the diagram, AP is maximum at L. To the left
of L, AP is rising and MP is greater than AP. To the right of L, AP is falling and MP is less
than AP.

4. A firm’s SMC schedule is shown in the following table. TFC is Rs.100. find TVC, TC,
AVC and SAC schedules of the firm:

Q 0 1 2 3 4 5 6
SMC - 500 300 200 300 500 800
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Ans:
Q SMC TFC TVC TC AVC SAC

0 - 100 0 100 0 0

1 500 100 500 600 500 600

2 300 100 800 900 400 450

3 200 100 1000 1100 333.33 366.66

4 300 100 1300 1400 325 350

5 500 100 1800 1900 360 380

6 800 100 2600 2700 433.33 450

Note: TFC is given.

TVC is obtained by adding SMC for each unit of output like 500 as it is taken, then
500+300=800; 800+200(SMC)=1000 and so on.
TC is TFC+TVC,
AVC is TVC divided by Q; and
SAC is TC divided by Q.
5. Explain the law of variable proportions with the help of a diagram.
Ans: The law of variable proportions says that the marginal product of a factor input initially
rises with the employment level, but after reaching a certain level of employment, it starts
falling.
The law of variable proportions can be explained with the help of the following table and
diagram.
Labour TP MPL APL
0 0 - -
1 10 10 10
2 24 14 12
3 40 16 13.33
4 50 10 12.5
5 56 6 11.2
6 57 1 9.5
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The above table shows the total product of labour, Marginal product of labour and
Average product of labour.
The third column gives us a numerical example of Marginal product of labour (MPL). The
values in this column are obtained by dividing change in TP by change in Labour
(MPL = ∆TPL/∆L).
The last column gives us a numerical example of average product of labour (APL). The values
in their column are obtained by dividing TP by Labour. APL=TPL/L
If we plot the above table in graph, placing labour on X axis and output on Y axis, we get
the curves shown in the diagram below:

Units of Labour

The TP increases as units of labour increases. But the rate at which it

increases is not constant. An increase in labour from 1 to 2 increases TP by 10 units. An increase
in labour from 2 to 3 increases TP by 12 units. The rate at which TP increases is shown by the MP.
The MP first increases (till 3 units of labour) and then begins to fall. This tendency of the MP to
first increase and then fall is called the law of variable proportions.
The law of variable proportions is also known as law of diminishing marginal
product. It occurs because of change in factor proportions. Factor proportions represent the
ratio in which the two inputs are combined to produce output. As we hold one factor fixed and
keep the other increasing, the factor proportions change. Initially, as we increase the amount of
the variable input, the factor proportions become more and more suitable for the production and
marginal product increases. But after a certain level of employment, the production process
becomes too crowded with the variable input - Labour.
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In the above diagram, TP is Total Product curve which is increasing in different

proportions due the change in labour input. The point F where the total product stops increasing
at an increasing rate and starts increasing at the diminishing rate is called the point of
inflexion. The AP and MP curves are increasing in the beginning and decreasing later. But the
change in MP is greater than change in AP.

VIII Assignment and project-oriented questions.

1. Find the missing products of the following table.

2.
Factor 1 TP MP1 AP1
0 0 0 0
1 10 - 10
2 24 - 12
3 - - 13.33
4 - 10 -
5 - 6 11.2
6 57 1 9.5

Ans:
Factor 1 TP MP1 AP1
0 0 0 0
1 10 10 10
2 24 14 12
3 40 16 13.33
4 50 10 12.5
5 56 6 11.2
6 57 1 9.5