Production function shows is the subject factor may be defined as

the maximum quantity of a matter of the Law the change in total product
commodity that can be of Variable resulting from the
produced per unit of time, Proportions. additional unit of a variable
with given amounts of factor.
inputs, when the best Long-run
production technique is production
used. The nature of function studies
production function the change in Returns to a factor means
depends upon the time output when all the change in physical output
period allowed for inputs used in the of a good when the
adjustment of the inputs. production of a quantity of one factor is
good are changed increased while the
Short run refers to the simultaneously and quantity of other factors
period of time in which the in the same remains constant.
amount of some inputs proportion. In this
Law of Diminishing
cannot be changed. case, the scale of
Marginal Returns states
production is
that in all production
Long run is defined as the changed. This is
processes, adding more of
time period in which all the subject matter
one factor of production,
factors of production can of returns to scale.
while holding one or more
be varied.
of other inputs constant,
Total Product (TP)
will at some point yield
Fixed factors are those refers to the total
lower per unit returns.
factors which remain amount of a
Diminishing returns occurs
unchanged at all levels of commodity
in the short run when at list
output. produced during
one factor is fixed.
some period of
Variable factors are those time by combining
Three stages of production
factors whose quantity different factors of
are:
changes with change in production.
output level. Stage of Increasing Returns
Average Product characterised by increasing
Short run production (AP) of a variable AP, although with MP
function refers to a factor refers to the increasing initially, but
situation where we study output per unit of falling later. TP increases
the change in output when variable factor. at an increasing rate at first,
only one input is variable and then at a decreasing
and all other inputs are Thus, rate. This stage is explained
fixed. In this case, factor Marginal Product in terms of fuller utilisation
proportion is changed. This (MP) of a variable
of fixed factors and optimum level of of inputs are zero. These
division of labour. output. An lines are used to separate
isoquant (or, Iso- the efficient ranges (with
Stage of Diminishing product, or, equal- positive slope of isoquants)
Returns is characterised by product curve) from the inefficient ranges
both AP and MP shows the various (with negative slope of
decreasing while TP combinations of isoquants). Thus, ridge
increases at a diminishing the two inputs at a lines indicate the
rate. This is the actual stage given level of boundaries of the efficient
of operation. This stage output. The slope ranges of output on the
arises because of of an isoquant is isoquants.
disturbances in optimum known as marginal
factor propositions and rate of technical In an isoquant map, the
imperfect substitutability of substitution ridge lines indicate the
factors. (MRTSL,k) and is boundaries of the economic
equal to the ratio region of production.
Stage of Negative Returns of (MPL /MPk ). ‡ At equilibrium,
is characterised by  Returns to Scale. The
diminishing TP; AP addition of output that
decreases but remains results from an increase in
positive, and MP is An isoquant map all inputs by some
negative. This stage is represents the proportion. If the output
explained in terms of whole array of increases by a greater
managerial problems. isoquants on a proportion than the
graph. Properties proportion of input
Marginal Rate of Technical of isoquants: increases, the firm
Substitution (MRTS). is experiencing increasing
Given two inputs X, and Y, downward sloping returns to scale. If the
the marginal rate of to the right output increases by the
technical substitution of X same proportion as the
for Y represents the no two isoquants inputs, the firm is
amount of X that a firm intersect or touch experiencing constant
must add to replace the each other returns to scale. Finally, if
reduced amount of Y so as the output increases by a
to maintain the same Isoquants are smaller proportion than the
amount of output. convex to origin. increases in inputs, the firm
is experiencing decreasing
When only two inputs vary, Ridge Line. It is returns to scale.
we can use isoquants to the locus of points  Technological change
find the optimum input of isoquants where shifts the production
combination for the marginal product function upward.
  Private cost refers to the  AFC curve  Long-run cost is the least
cost incurred by an slopes downward cost of producing each
individual firm in continuously from level of output when all
producing a commodity. left to right. factors of production are
 Social cost refers to the  AVC curve is variable. To produce a
cost that society has to bear the per-unit cost of product at the least cost,
because of the production the variable the firm should spend its
of a commodity. factors. money in such a way that
 Explicit cost refers to  AVC curve is the last Birr spent on each
money expenses incurred U-shaped due to factor of production brings
in purchasing or hiring the the law of variable equal marginal product.
factor services.  Implicit proportions. There is an inverse
cost refers to the imputed  ATC (or simply relationship between
value of the inputs owned AC) is the per-unit production and cost: TVC
by the firm and used by it cost of all factors and TP are inversely
in its own production. of production used related; AVC and AP are
 Economic cost consists in production. inversely related; MC and
of explicit cost and implicit  ATC curve is MP are inversely related.
cost. the vertical
 Total fixed cost is the summation of the  PARADOX OF
total cost incurred on fixed AVC and AFC VALUE
factors. It does not change curves. It is U-
with change in output. shaped.
 Total variable cost is the  Marginal cost is  EXCHANGE VALUE
total cost incurred on the addition to
variable factors. It changes total cost as one
with change in output. more unit of output
 TFC curve is a straight- is produced.
line curve parallel to the  MC curve is U-  OPPORTUNITY COST
horizontal axis. shaped due to the
 TVC curve is concave law of variable  UTILITY
downward, up to some proportions.
level of output, then  The relationship  MARGINAL UTILITY
concave upward. between AC and
 TC curve increases at a MC is: ^ when,  LAW OF
decreasing rate first and MC < AC, AC DIMINISHING
then at an increasing rate. falls; ^ when MC > MARGINAL UTILITY
 AFC is the per-unit cost AC, AC rises; ^
of the fixed factors. when MC = AC,
AC is minimum. marginal revenue:
the additional revenue
gained from selling
 one more unit of consumed, we ranking of preferences
output gain less rather than an actual
profit: additional cardinal measurement.
the difference satisfaction
Deriving Demand
between total from
revenues and total consuming Knowing how the
costs another unit. consumer behaves allows
profit-maximizing rule Thus even if a us to derive a demand
for a perfectly good were free curve. Let’s say that
competitive firm: and you could Suzette eats either an apple
produce the level of consume as or an orange as a snack.
output where much as you She has $12 to spend.
marginal revenue wanted, there Given that each fruit costs
equals marginal cost would be a two dollars, she will
limit to the maximize her utility by
Consumer Behavior
amount you purchasing 3 apples and 3
Utility would consume oranges. If we are looking
due to the law at the demand for oranges,
 Economists use the of diminishing this will give us one point
term utility as a marginal utility. on the demand curve. At a
measure of satisfaction,
price of $2.00, the quantity
joy, or happiness. How Maximizing
demanded of oranges is 3.
much satisfaction does a Utility
person gain from eating Indifference Curves
Utility values can
a pizza or watching a
be determined by Indifference curves and
movie? Measuring
an individual budget constraints allow
utility is based solely on
ranking his/her for a more in-depth
the preferences of the
preferences from analysis of demand. For
individual and has
least preferred to modeling purposes we will
nothing to do with the
most preferred. look at the two goods.
price of the good.
The resulting An indifference
 The law of diminishing
ranking or utility curve shows the different
marginal utility states
values are combinations of the two
that as more of the good
subjective or goods that yield the same
is consumed, the
individual. They level of utility, independent
additional satisfaction
are also ordinal of the price of the goods.
from another bite will
rather than Due to the law of
eventually decline. The
cardinal. Ordinal diminishing marginal
marginal utility is the
means that the utility, the indifference
satisfaction gained from
utility values curve between the two
each additional bite. As
simply define a goods is convex to the
more of the good is
origin. All combinations of spend and the price given their budget
the two goods (pizza and of pizza was $2 constraint. This occurs
shakes) that are on the and shakes were where the indifference
indifference curve (A, B, $1, then the curve is tangent to the
and C) yield the same level consumer could budget constraint
of utility, say Utility = buy four pizzas (combination A). Note that
100. Having more of good, ($8/$2) or eight combinations B and C cost
yields a higher level of shakes ($8/$1). the same amount as A;
utility (combination D) and Any combination however, A is on a higher
having less of the goods of the two goods indifference curve.
yields a lower level of that are on or Combination D yields that
utility (combination E). beneath the budget same utility as C and B but
constraint are doesn’t use all of the
Marginal Rate of
affordable, while income, thus the consumer
Substitution
those to the outside can increase utility by
The marginal rate of (farther from the consuming more.
substitution is the slope of origin) are Combination E is preferred
the curve and measures the unaffordable. to combination A, but is
rate at which the consumer unattainable given the
A greater income
would be willing to give up budget constraint.
will cause a
one good for the other
parallel shift
while maintaining the same
rightward of the
level of utility. Thus the
budget constraint
marginal rate of
while a decrease in
substitution reflects the Income and Substitution
income will cause
ratio of marginal utilities Effects
a parallel shift
between the two goods.
leftward. When discussing why the
Budget Constraint demand curve is downward
Utlity
The budget constraint Maximization sloping, we outlined the
indicates the combinations substitution effect and
Given the goal of income effect. We can
of the two goods that can
consumers is to observe the changes in
be purchased given the
maximize utility quantity demanded along
consumer’s income and
given their budget the demand curve due to
prices of the two goods.
constraints, they the change in price;
The intercept points of the
seek that however, the indifference
budget constraint are
combination of curves and budget
computing by dividing
goods that allows constraints can help us
the income by the price of
them to reach the analyze the size of the
the good. For example, if
highest
the consumer had $8 to
indifference curve
income and substitution macroeconomics purchase paper in either the
effects. known 100 or 200 sheet packs and
as Keynesian only value the number of
The income effect involves
economics. The sheets. You are indifferent
a change in purchasing
theory draws between having two one-
power and a change in
comparisons hundred sheet packages or
demand or consumption. If
between one two-hundred sheet
purchasing power
production, package. In the case of
decreases, demand for a
individual income, perfect substitutes, there
product usually decreases.
and the tendency are three different
When the price of a to spend more. outcomes that will
product rises relative to maximize utility. If the
Extreme Cases
alternative products in the price of one package,
same market, consumers When examining yields a lower per sheet
will substitute one of the indifference curves cost, the consumer will buy
lower-priced alternatives and budget only that good, so
for the now higher-priced constraints, we can consumption will take
product. look at a few place at one of the two
extremes. One intercepts. The third
The income effect is the outcome is when the
extreme case
resulting change in demand budget constraint has the
would be if the
for a good or service same slope as the
two goods
caused by an increase or indifference curve. In this
are perfect
decrease in a consumer's case, any combination
complements. For
purchasing power or real along the budget constraint
example, you do
income. The substitution will yield the same level of
not get additional
effect occurs when utility.
satisfaction from
consumers replace one
having another
product with another due to
right shoe, unless
price changes and personal
you have a left
finances.
shoe to go with it.
The marginal propensity to In the case of
consume explains how perfect
consumers spend based on complements, you
income. It is a concept always consume at
based on the balance the minimum
between the spending and combination of the
saving habits of two goods.
consumers. The marginal
Another extreme
propensity to consume is
is perfect
included in a theory of
substitutes. You