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The document discusses the theory of production and costs in engineering economics and project management, detailing the transformation of inputs into outputs and the factors of production including land, labor, capital, and entrepreneurship. It explains fixed and variable factors, production functions, cost analysis, and the relationships between average and marginal costs. Additionally, it includes numerical examples for profit maximization and the shapes of various cost curves.

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12 views

Factors of Production_new - Copy

The document discusses the theory of production and costs in engineering economics and project management, detailing the transformation of inputs into outputs and the factors of production including land, labor, capital, and entrepreneurship. It explains fixed and variable factors, production functions, cost analysis, and the relationships between average and marginal costs. Additionally, it includes numerical examples for profit maximization and the shapes of various cost curves.

Uploaded by

tusharsingh2379
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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ENGINEERING ECONOMICS

&
Project Management

Theory of Production & Costs

Sampad Biswas
Lecturer in M.E., Kanyapur Polytechnic
Theory of Production
Production is the process of transforming inputs (resources such as labor, capital, and raw
materials) into outputs (goods and services) to satisfy human needs.

Outputs:
Goods: Tangible products (e.g., food, clothes, cars).
Services: Intangible products (e.g., education, healthcare, transportation).

Factors of Production
i. Land
ii. Labour
iii. Capital
iv. Entrepreneur or Organisation
Factors of Production
Land
It is a fixed factor of production
It is a Free gift of nature
It is a Passive factor of production (cannot produce anything on its own)
It is heterogenous (The price of land differs based on location, fertility,
connectivity and productivity)

Labour
It is an active factor of production (can function on its own)
It is perishable (if a labourer doesn’t work then his one day’s work is lost forever)
Labour can be both manual and intellectual.
Factors of Production (Continued…)
Capital
It is a produced factor of production
Machines, tools, buildings, railways, roads & raw materials are all included in capital
The supply of capital is elastic

Entrepreneur & Organisation


Performs the role of an administrator (Planning, development & expansion)
Functions as a co-ordinator of different factors of production
Responsible for marketing of finished products
Fixed Factor & Variable Factor

Fixed factor Variable factor

Quantity cannot be changed It can be changed in the short run as well as long run

The cost of this inputs are called fixed cost The cost of variable inputs are called variable cost

Remains the same in short period Can be used in different amounts

Ex. Land, building, capital Ex. Raw materials, labour


Production Function
Production function refers to the relationship among units of the factors of production (inputs) and the resultant quantity of a good produced (output).
It is expressed as: Q = f (N, L, K, T) where, Q = Quantity of output, N = Land; L =Labour; K = Capital; & T = Technology.

Law of Variable Proportions/ Law of diminishing marginal returns


1. Law of Diminishing Returns (Variable Proportions):
When we keep adding more workers (labour) to a fixed thing (like land or machine), after some time, the extra work done by each new worker starts to go down.

2. Stages of Production:
Stage 1: Increasing Returns to Scale (Total output increases at an increasing rate).
Stage 2: Diminishing Returns to Scale (Total output increases at a decreasing rate).
Stage 3: Negative Returns to Scale (Total output decreases).
Short-run Production function

In the short run, at least one factor of production (e.g., capital) is fixed while other
factors (e.g.,labor) are variable.
All units of the variable factor are homogeneous.
There is no change in the state of technology.
There is no change in the price of the product.
Long-run Production function

• All the factors of production (such as land, labour and capital) are variable but organization is
fixed.
• There is perfect competition in the market.
• In the long-run the relationship between output & the scale of inputs is explained by the
Laws of returns to scale

Law of Returns to scale has three phases


Increasing Returns to Scale:
• In this case if all inputs are increased by 1%, output increase by more than 1%
Constant Returns to Scale:
• In this case if all inputs are increased by 1%, output increases exactly by 1%.
Diminishing Returns to Scale:
• In this case if all inputs are increased by 1%, output increases by less than 1%.
Cost Analysis
Cost refers to the total expenses incurred in the production of a commodity.

Cost analysis refers to the change in cost in relation to one or more production criteria
such as size of output, scale of production, prices of factors and other economic variables.

The functional relationship between cost and output is expressed as ‘Cost Function’.

A Cost Function may be written as C = f (Q)


TC = Q3–18Q2 + 91Q + 12
where, C = Cost & Q = Quantity of output
Short Run Cost Curves
Fixed Cost
 Fixed cost stays the same even if the amount of production changes.
Even if the output is increased, decreased or it becomes zero the cost remains same.
Ex. Wages, rent, machines insurance premium, property taxes, license fee etc
Short Run Cost Curves (Continued…)
Variable Cost
These costs change when the amount of production changes.
Examples of variable costs are: cost of raw materials, fuel cost, electricity charges, etc.
Short Run Cost Curves (Continued…)
Total Cost
Total Cost means the sum total of all payments made in the production.
Total cost is the summation of Total Fixed Cost (TFC) and Total Variable Cost (TVC)
TC = TFC + TVC
Short Run Cost Curves (Continued…)
Average Fixed Cost (AFC)
• It means how much fixed cost is there for one product.. It is obtained by dividing the total
fixed cost by the quantity of output.
• AFC = TFC / Q
Short Run Cost Curves (Continued…)
Average Variable Cost (AVC)
 It means how much variable cost is there for one product. You
It is obtained by dividing total variable cost (TVC) by the quantity of output (Q).
AVC = TVC / Q where, AVC denotes Average Variable cost, TVC denotes total variable cost
and Q denotes quantity of output.
Short Run Cost Curves (Continued…)
Average Total Cost
 It means how much total cost is there for one product.
ATC = TC / Q where, AVC denotes Average Variable cost, TVC denotes total variable cost and Q
denotes quantity of output.
Short Run Cost Curves (Continued…)
Marginal Cost
It is the extra cost when we make one more product.
 It helps to decide whether to produce more or not.
Marginal Cost = Change in Total Cost (ΔTC) ÷ Change in Quantity (ΔQ)
At first, MC goes down because we use workers and materials better.
Relationship between Avg Cost & Marginal Cost

When AC is falling, MC lies below AC.

When AC becomes constant, MC also


becomes equal to it.

When AC starts increasing, MC lies above the


AC.

MC curve always cuts AC at its minimum


point from below
Long run cost curve
In the long run all factors of production become variable.

 The size of the company can also grow in the long run.

There is no fixed input or fixed cost in the long run.

Long Run Average Cost (LAC) = Total Cost ÷ Output

The LAC curve is derived from short-run average cost curves.

It shows the minimum cost for making different amounts of


products.
Questions

Ans: Option c
Ans: Option b

The shape of short run Average Fixed Cost (AFC) is : Rectangular Hyperbola
Numericals (Profit Maximization)
If the cost function is given as C=5q2-50q+8 then find out the profit maximizing level of
output & also the profit if market price is given as Rs10/- per unit. (2024)

Profit = Revenue – Cost


Revenue= price per unit x quantity = 10q
Cost C = 5q2-50q+8

Profit (Z) = Revenue – Cost = 10q - 5q2 + 50q - 8 = 60q – 5q2 – 8

For profit maximization:

= 60 – 10q = 0 q= 6 ( Profit maximizing level of output)

Max profit: Zmax = 60x6 – 5x62 – 8 = 172


Numericals (Profit Maximization)
If the demand is given by p= 80–3q & Total cost is C = 12+2q2, then write the profit
function. Calculate profit maximizing price & profit maximizing quantity. (2023)

Solution:
Price: p= 80 – 3q Total Cost: C = 12+2q2
Profit function(Z)= (80 – 3q)x q – (12+2q2) = 80q-3q2-12-2q2 = 80q-5q2-12

=0 80-10q=0 q=8
For profit maximization:

Profit maximizing price: p= 80-3x8=80-24=56 p=56


Questions (Continued)
Draw a single diagram to show the shapes of Average Fixed Cost, Average Variable
Cost, Average Total Cost & Marginal Cost. (2023)
Thank You

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