Theory of Production and Cost

Q1. Define following terms:

a. Production
b. Factors of Production

Answer:
a. Consuming means extracting utility from matter, producing means creating utility into matter.
Fraser
Meaning
Production is another important economic activity. It directly or indirectly satisfies the wants and needs of the
people. Satisfaction of human wants is the objective of production. Production is the conversion of input into
output. The factors of production and all other things which the producer buys to carry out production are called
inputs. The final goods and services produced are known as output. In economics, the term production is not the
same as in common language where it is usually taken to mean ‘creation’ of something. In economics, the term
production carries a wider connotation. It stands for creation of ‘value’, which can be of two varieties, namely ‘use
value’ and ‘exchange value’. Thus, production is the activity which creates or adds utility and value. According to
Edwood Buffa, “Production is a process by which goods and services are created”.
b. Factors of Production
Q2. Explain theory of production.
Answer:
Q3. Explain Law of Variable Proportions. Describe three stages of production. Which is the optimal stage for a
producer to operate.
Q. Explain Laws of Returns to Scale. Describe increasing, constant and diminishing returns to scale.
Q.1. Define Average Product (AP) and Marginal Product (MP).

Ans. AP is the total product per unit of a variable input. MP is the change in total product consequent upon a
change in variable input.

Q.2. What is meant by ‘Short Run’ and ‘Long Run’ in the analysis of a firm.
Or
Distinguish between ‘short-run’ and ‘long run’ in the context of production.
Ans. Short run is that time period when a firm cannot change all its inputs; some are held fixed. Output can,
therefore, be increased by changing only variable inputs. Long period is that time period when the firm can
change all its inputs including fixed inputs. In the long run, all inputs are, therefore, variable.

Q.3. How do total product, average product and marginal product change due to a change in the use of
one input, keeping other inputs constant?

Ans. For simplicity, we are assuming that labour is the only variable input while other inputs are constant.
Now, if number of labourers is increased with fixed inputs, initially total product (TP), average product (AP)
and marginal product (MP) will increase as TP increases at an increasing rate.

Further employment of labour will cause TP to increase at a diminishing rate. Consequently, AP and MP will
decline. When TP becomes maximum, MP becomes zero. Now, more employment of labour will lead to a fall
in TP and MP will be negative.

Q.4. What is meant by production function?

Ans. A production function is a technological or an engineering relationship between inputs and output.

A production function is usually written as:

Q = f(a, b, c, d…)

where Q is the amount of output; and a, b, c, d, etc., are inputs.

Though production function refers to a technological relationship, the concept is useful in economic theory as
it is related to the costs of production of a unit.

Q.5. What is the difference between returns to an input and returns to scale?

Ans. By returns to an input we mean the laws of change in output following a change in one or two inputs,
keeping other inputs constant. Thus, this law remains valid in the short run. If all inputs are changed and
output changes then we obtain laws of returns to scale which is a long-run phenomenon.

Q.6. What is meant by scale of production?

Ans. In the long run there are no fixed inputs; all inputs are variable. A firm can install a new machine or
build up a new factory shade or switch over from one technique of production to another in the long run. This
means that a firm can change its scale of operations or scale of output by changing all its inputs. This is called
a change in scale of production.

Q.7. Define increasing returns to scale (IRS), constant returns to scale (CRS) and diminishing returns
to scale (DRS).

Ans. IRS:

IRS is characterised by a situation where doubling or trebling of all inputs causes output to increase more than
proportionately then we say that the returns to scale are increasing.
CRS:

If a given percentage increase in inputs causes output to increase by the same percentage, then CRS is said to
have occurred. If output is doubled following the doubling of inputs then output growth is subject to CRS.

DRS:

Output growth is subject to DRS if a given percentage increase in inputs leads to a smaller percentage
increase in output. This means that doubling of inputs causes output to increase less than double.

Q.8. What is an isoquant?

Ans. An isoquant shows different combinations of two inputs that produces a specified amount of output. On
an isoquant, same level of output is obtained by using different combinations of two inputs. That is why an
isoquant is called production indifference curve.

Q. 9. Define marginal rate of technical substitution (MRTS).

Ans. MRTS of labour for capital is the amount of capital that can be replaced by a 1 unit increase in labour,
so that output remains constant. That is

MRTSK for L = -∆K/∆L

or MRTSL for K = -∆L/∆K

Q.10. What is an iso-cost line?

Ans. An iso-cost line shows various combinations of two inputs, say, labour and capital, that can be
purchased for a given amount of expenditure. The slope of the iso-cost line is equal to the negative price ratio
of two inputs.

Q. 11. What do you mean by output expansion path?

Ans. By joining various points of tangency between isoquants and parallely shifted iso-cost lines, one obtains
output expansion path. It shows how input combinations change when output changes, keeping input prices
constant.

Q.12. What do you mean by economies of large scale production?

Ans. By scale of production we mean the size of a business or production unit. When a business unit expands
its size of production (by increasing all the factors of productions), it secures certain advantages. These are
known as economies of large scale production.

Q. 13. Define internal and external economies of large scale production.

Or

What is the internal economy of a firm?

Ans. Internal economies of production arise when the benefits or advantages of a firm’s expansion are
enjoyed by the firm itself. Thus, internal economies accrue only to the individual firm by its own
organisational ability and effort. These are called internal because the scale economies are within the control
of the firm.

External economies arise when an increase in a firm’s expansion produces favourable effects on other firms.
In other words, benefits of increased production spread to other firms in the industry or in the region. Thus,
external economies are available to all firms in the industry, irrespective of their sizes. These are called
external because the scale economies are outside the control of the firm.

Q.14. Name different types of internal and external economies of large scale production.

Ans. Internal economies of large scale production can be grouped into:

(a) Technological,

(b) Managerial,

(c) Marketing,

(d) Financial, and

(e) Risk Distributional Economies.

External economies are of the following types:

(a) Economies of localisation,

(b) Managerial,

(c) Marketing,

(d) Financial, and

(e) Risk Distributional Economies.

External economies are of the following types:

(a) Economies of localisation,

(b) Economies of research and information, and

(c) Economies of specialisation.

Q.15. What are diseconomies of scale?

Ans. Economies of scale can never be unlimited. As a result, expansion beyond a certain stage will not cause
costs to decline. Instead, it will rise as the firm expands. In other words, when the size of a firm becomes
large, possibilities for economies get exhausted and diseconomies set in.
Q Explain theory of cost.
Q. What do you mean by Producer’s Equilibrium? Explain.