producer behaviour and supply

PRODUCER

BEHAVIOR AND SUPPLYMADE BY:

RISHABH GUPTAXII ‘B’

ROLL NO. 36

PRODUCTION

FUNCTION

THEORY OF PRODUCTION

Production means transformation of inputs into outputs.

Supply of product refers to the quantity supplied at the given price.

Which depends upon Relationship between input and output Prices of inputs Managerial efficiency

THEORY OF PRODUCTION

It states the maximum amount of output that can be

produced with any given quantities of various inputs.

Particular period of time

Flow concept : Flow of inputs leads to flow of output

PRODUCTION FUNCTION The functional relationship under

given technology between input and output, per unit of time.

Q = f ( L, K)

OutputInputs

TYPES OF PRODUCTION FUNCTION

DIFFERENCE BETWEEN SHORT RUN AND LONG RUN

Basis Short Run Long Run

MeaningShort run refers to the period in which only variable factors are

changed

Long run refers to the period in which all factors can be

changed.

Price Determination Demand is more active Both demand & supply

than supply. play an important role.

Classification Factors are classified as fixed & All factors are variable.

variable.

Variable factors versus fixed factors

Variable factors: are factors of which the employment varies with output.

Fixed factors: are factors of which the employment does not vary with output.

Three variables are defined to measure the output:

____________________: is the whole amount of output produced by all the factors employed.

Total product (TP)

____________________: is the output per unit of the variable factor employed.

____________________: the change in output resulting from employing an additional unit of the variable factor.

Average product (AP)

Marginal product (MP)

TP = QLQ

LTPAP L

TPMP

Units of Labour

L

Total Product(Quintals) Q

Marginal Product(Quintals)

Average Product(Quintals)

1 80 80 80

2 170 90 85

3 270 100 90

4 368 98 92

5 430 62 86

6 480 50 80

7 504 24 72

8 504 0 63

9 495 -9 55

10 480 -15 48

IR

DR

Negative

SHORT – RUN PRODUCTION FUNCTIONLAW OF VARIABLE PROPORTION

One – factor varying, quantities of other factor as fixed

Law of variable proportion: It’s the study of the effect on output of variations in factor

proportion.

As we increase quantity of only one input keeping other inputs fixed, total product initially increases at an increasing rate, then at a decreasing rate and finally at a negative rate.

It’s a new name for Law of Diminishing returns

The state of technology is assumed to be given / unchanged

Some inputs whose quantities is fixed Measured in physical terms.

The slope of TP curve is

MP.

The slope of TP curve is

MP.

The slope of the line joining the origin and a point on TP

is AP.

The slope of the line joining the origin and a point on TP

is AP.

Notice the points where MP = maxi.; MP=AP &

MP = 0.

Notice the points where MP = maxi.; MP=AP &

MP = 0.

F

H

DS

Stage 1 Stage 3Stage 2

STAGES OF LAW OF VARIABLE PROPORTION

STAGES

Stage 1.

TP increases at an increasing rate upto a point. MP of variable factor is rising Point F (Point of Inflection), TP curve rises but

its slopes decline – TP is increasing at a diminishing rate. MP starts falling but its positive.

AP reaches its highest point MP of variable factor rises and then falls MP of fixed factor is negative Quantity of fixed factor is too much to the

variable factor

STAGES

Stage 2. TP increases at a diminishing rate, reaches its

maximum point MP, AP are diminishing but positive MP becomes Zero

Stage 3. TP slopes downwards MP of variable factor is Negative

IN WHICH STAGE THE PRODUCER SHOULD PRODUCE Stage 3 – No

MP of variable factor is negative

Stage 1 – No

MP of fixed factor is negative

Full utilisation is not there

Stages of

Economic absurdity / Economic non-sense /

Non- economic regions

Stage 2 – Yes

MP and AP are positive but diminishing

CAUSES Increasing Returns

Quantity of fixed factor is abundant than variable factor

Fixed factor are indivisible With addition of variable factor , fixed factor is

more effectively and intensively utilised. More units of variable factor are employed , the

efficiency of variable factor increases –“specialisation of labour”.

Diminishing Returns The maximum point has reached. The amount of the variable factor is sufficient to

ensurethe efficient utilisation of fixed factor.

The contribution to the production made by the variable

factor after a point become less as the additional units

of the variable factor have less of fixed factor.

CAUSES

Negative ReturnsNumber of variable factor become too excessive to the fixed factor Marginal Product of variable factor is negative.

Diminishing returns occur because the factors of production are Imperfect substitutes for one another.

There is a limit to which one factor of production can be substituted for another.Elasticity of substitution between factors is not infinite.

RELATION BETWEEN MPP AND TPP

As long as MPP increases, TPP increases at an increasing rate.

When MPP decreases, TPP increases diminishing rate.

When MPP is Zero, TPP is maximum.

When MPP is negative, TPP starts decreasing.

COSTFUNCTI

ON

COST CONCEPTS DEFINED

Cost is the value of the inputs used to produce its output; e.g. the firm hires labor, and the cost is the wage rate that must be paid for the labor services

For factors hired or employed by a firm:

The costs are (the value of) the highest-valued alternative use of the money spent in hiring them.

They are called explicit costs , as they involve a transfer of money.

For factors owned by a firm:

The costs of using these factors are (the value of) the highest-valued alternative uses of the factors.

They are called implicit costs or imputed costs , as they do not involve a transfer of money.

COST FUNCTION Cost function : Functional relationship

between output and cost.C=f(q)

Where f=functional relationshipc= cost of production

Output

= ???

Total cost

is the whole amount of payments to all factors used in producing a given amount of output (Q), composed of:

Total fixed cost (TFC): is the whole amount of payments to fixed factors.

Total variable cost (TVC): is the whole amount of payments to variable factors.

TVC = w x L• total variable cost:

Formula:

TC = TFC +TVCTotal Cost:

Assume two factors only:

Capital (fixed factor) and labour (variable factor)

L units of labour are employed at a wage rate of w.

a constant independent of output

• total fixed cost:

TOTAL VARIABLE COST VS. TOTAL FIXED COST

Basis TVC TFC

Meaning Vary with the level of output Do not vary with the level of output

Time period Can be changed in short period Remain fixed in short period

Cost at zero output

Zero Can never be zero

Factors of production

Cost incurred on all variable factorsCost incurred on fixed factors of production

Shape of the cost curve

Upward sloping Parallel to x axis

RELATION BETWEEN TC, TFC AND TVC

TFC is horizontal to x axis. TC and TVC are S shaped

(they rise initially at a decreasing rate, then at a constant rate & finally at an increasing rate) due to law of variable proportions.

At zero level of output TC is equal to TFC.

TC and TVC curves parallel to each other.

Average cost / Average total cost (ATC)

is the cost per unit of output, composed of :

• average fixed cost (AFC): the fixed cost per unit of output.

• average variable cost (AVC): the variable cost per unit of output.

Formula:

AVCAFCQTVCTFC

QTCATC

Average Total Cost:

QTFCAFC average fixed cost:

AP

w

L

Qw

L

QL

Lw

Q

Lw

Q

TVCAVC

average variable cost:

ATC curve and AVC curve will come closer and closer as the amount of

output increases (∵ATC = AFC + AVC and AFC drops continuously).

ATC curve and AVC curve will come closer and closer as the amount of

output increases (∵ATC = AFC + AVC and AFC drops continuously).

AVC curve is U-shaped. (∵ AVC = w/AP and AP is

inverted-U shaped.)

AVC curve is U-shaped. (∵ AVC = w/AP and AP is

inverted-U shaped.)

AFC curve drops continuously.

(∵AFC = TFC/Q)

AFC curve drops continuously.

(∵AFC = TFC/Q)

Features:

The turning point of ATC curve (b) occurs at a larger output than the turning point of AVC curve (a).

The turning point of ATC curve (b) occurs at a larger output than the turning point of AVC curve (a).

(b)(a)

∵ At (a), the fall in AFC is > the rise in AVC initially but at (b), the fall in AFC is < the rise in AVC

eventually

∵ At (a), the fall in AFC is > the rise in AVC initially but at (b), the fall in AFC is < the rise in AVC

eventually

Marginal Cost

is the change in total cost for producing an additional unit of output, composed of :

• marginal fixed cost (MFC): is the change in fixed cost

for producing an additional unit of output

• marginal variable cost (MVC): is the change in variable cost for producing an

additional unit of output.

Formula:

0

QTFCMFC marginal fixed

cost:

MVCMFCQTVCTFC

QTCMC

Marginal cost:

marginal variable cost:

MP

w

L

Qw

L

QL

Lw

Q

Lw

Q

TVCMVC

MC curve passes through the minimum points of AVC curve and ATC curve.

MC curve passes through the minimum points of AVC curve and ATC curve.

MC or MVC curve is

U-shaped

As TFC is a constant, MFC = 0. So MC = MVC. As TFC is a constant, MFC = 0. So MC = MVC.

MC = MVC = w/MP. As MP curve is inverted-U shaped, MC

or MVC curve is U-shaped.

MC = MVC = w/MP. As MP curve is inverted-U shaped, MC

or MVC curve is U-shaped.

REVENUE

REVENUE CONCEPTS DEFINED

Revenue refers to the amount received by a firm from the sale of a given quantity of commodity in the market.

Revenue

Total Revenue

Average Revenue

Marginal Revenue

REVENUE CONCEPTS Total Revenue (TR)

It refers to total receipts from sale of a given quantity of a commodity. TR = Quantity x Price.

Average Revenue (AR)It refers to revenue per unit of output sold. AR = Total Revenue / Quantity.

Marginal Revenue (MR)It refers to the additional revenue generated from the sale of an additional unit of output. MR = change in TR /change in no. of units.

AVERAGE REVENUE When a firm has no control over price, it can sell any

amount at a given price. Accordingly, firms demand curve (or AR curve) is a horizontal straight line as in.

When a firm has partial or full control over price, it can sell more of a product only by lowering its price. Accordingly, its demand curve (or AR curve) slopes downward, showing a negative relationship between price and output as in.

RELATION BETWEEN TR, AR AND MR

When marginal revenue curve declines till point M in part B, total revenue is increasing at diminishing rate as shown by the segment O to B in part A.

When marginal revenue becomes zero at point M in part B, total revenue is at its maximum as shown by point B in part A.

When marginal revenue falls, the average revenue also falls but lies above the marginal revenue curve. Implying that in a situation of falling price, MR falls even faster.

After point M, marginal revenue becomes negative. Now total revenue starts diminishing.

A situation of zero AR obviously implies a situation of zero TR. (Zero price situation is not a general phenomenon, but, of course has examples as in government or charitable hospitals where medicines are given to the patients at zero price.)

Note CarefullyMarginal revenue can be positive, zero or negative but average revenue (or price) cannot

be negative

BREAK-EVEN POINTIn microeconomics, break-even is

said to occur when:

TR = TC

Or,  or P = AC

A firm is just covering all its costs.

Break-even is struck at point Q where AR (= Price) = AC = LQ = OP. A firm is just covering its costs as price (= OP) happens to be equal to AC (average cost) = LQ. Equilibrium is at point Q. It is to be carefully noted that the break-even point Q also happens to be the point of firms equilibrium where both the conditions of equilibrium are satisfied, viz

(i) MC = MR, and

(ii) (ii) MC is rising.

SHUT-DOWN POINTShut-down point occurs when a firm is just

covering its variable costs only. Or, it is a situation when:

TR = TVC or  or AR = AVC

Here, the firm is incurring loss of fixed cost. Does it mean that the firm will suspend production of the commodity? Not necessarily. It may continue to produce because the loss of fixed cost is to be incurred even when output is suspended.

Shut-down is struck at point Q where

AR (Price) = AVC = LQ = OP.

A firm is operating with a price just covering its AVC. Thus, price (or average revenue = OP) = average variable cost (= LQ). Note that shut-down point Q also happens to be a point of equilibrium where both the conditions of equilibrium are satisfied, viz.

(i) MR = MC, and

(ii) (ii) MC is rising.

PRODUCER’S

EQUILIBRIUM

INTRODUCTION

Having understood the behavior of revenue and costs for a firm, it is time now to understand how a producer strikes his equilibrium. As a producer, you will always like to maximize the difference between your total revenue (TR) and total cost (TC), so that your profit is maximized.

We will be studying how a producer attains equilibrium through MR-MC Approach.

MR-MC APPROACH Under perfect

competition, a firm is in equilibrium in short-run when following two conditions are fulfilled.

1) MR = MC2) MC cuts MR from

below or MC is rising at the point of equilibrium. 

Producer’s equilibrium is determined at OQ level of output corresponding to point E as at this point: (i) MC=MR; and (ii) MC is greater than MR after MC=MR level of output.

Both conditions are needed for producer’s equilibrium

I. MC=MR: we know, MR is the addition to TR from sale of one more unit of output and MC is the addition to TC for increasing production by one unit. Every producer aims to maximize his profits. For this, a firm compares its MR with its MC. Producer is not in equilibrium when MC<MR as it is possible to add more profits and also not when MC>MR as benefit is less than cost. It means firm will be at equilibrium when MC=MR.

II. MC is greater than MR after MR=MC output level: MC=MR is a necessary condition but not sufficient enough. It is because MR=MC may occur at more than one level of output. But only that output level is the equilibrium output when MC becomes greater than MR after the equilibrium. It is because if MC is greater than MR, then producing beyond MC=MR output will reduce profits. But if MC is less than MR beyond MC=MR output, it is possible to add to profits by producing more.

SUPPLY

SUPPLY Individual supply refers to quantity of a

commodity that an individual firm is willing and able to offer for sale at a given price during a given period of time.

Individuals supply factors of production to intermediaries or firms.

SUPPLY The analysis of the supply of produced

goods has two parts:

– An analysis of the supply of the factors of production to households and firms.

– An analysis of why firms transform those factors of production into usable goods and

services.

THE LAW OF SUPPLY

There is a direct relationship between price and quantity supplied.Quantity supplied rises as price rises, other

things constant.Quantity supplied falls as price falls, other

things constant.

LAW OF SUPPLY

Law of Supply As the price of a product rises, producers

will be willing to supply more. The height of the supply curve at any

quantity shows the minimum price necessary to induce producers to supply that next unit to market.

The height of the supply curve at any quantity also shows the opportunity cost of producing the next unit of the good.

THE LAW OF SUPPLY The law of supply is accounted for by

two factors:

– When prices rise, firms substitute production of one good for another.

– Assuming firms’ costs are constant, a higher price means higher profits.

THE SUPPLY CURVE

The supply curve is the graphic representation of the law of supply.

The supply curve slopes upward to the right.

The slope tells us that the quantity supplied varies directly – in the same direction – with the price.

S

A

Quantity supplied (per unit of time)

0

Pric

e (p

er u

nit)

PA

QA

A SAMPLE SUPPLY CURVE

SUPPLY CURVE DVDS

SHIFTS IN SUPPLY VERSUS MOVEMENTS ALONG A SUPPLY CURVE

Supply refers to a schedule of quantities a seller is willing to sell per unit of time at various prices, other things constant.

Quantity supplied refers to a specific amount that will be supplied at a specific price.

SHIFTS IN SUPPLY VERSUS MOVEMENTS ALONG A SUPPLY CURVE

Changes in price causes changes in quantity supplied represented by a movement along a supply curve.

SHIFTS IN SUPPLY VERSUS MOVEMENTS ALONG A SUPPLY CURVE

A movement along a supply curve – the graphic representation of the effect of a change in price on the quantity supplied.

SHIFTS IN SUPPLY VERSUS MOVEMENTS ALONG A SUPPLY CURVE

If the amount supplied is affected by anything other than a change in price, there will be a shift in supply.

SHIFTS IN SUPPLY VERSUS MOVEMENTS ALONG A SUPPLY CURVE

Shift in supply – the graphic representation of the effect of a change in a factor other than price on supply.

SHIFTS IN SUPPLY VERSUS MOVEMENTS ALONG A SUPPLY CURVE

Change in quantity supplied (a movement

along the curve)

CHANGE IN QUANTITY SUPPLIED

Pric

e (p

er u

nit)

Quantity supplied (per unit of time)

S0

$15A

1,250 1,500

B

SHIFT IN SUPPLYP

rice

(per

uni

t)

Quantity supplied (per unit of time)

S0

Shift in Supply(a shift of the curve)

S1

$15 A B

1,250 1,500

SHIFT FACTORS OF SUPPLY

Other factors besides price affect how much will be supplied:Prices of inputs used in the production of a

good.Technology.Suppliers’ expectations.Taxes and subsidies.

FACTORS THAT SHIFT SUPPLY

Prices of RelatedGoods and Services

Number Of

Producers

ExpectationsOf

Producers

TechnologyAnd

Productivity

ResourcePrices

Supply

PRICE OF INPUTS (RESOURCE PRICES)

When costs go up, profits go down, so that the incentive to supply also goes down.

TECHNOLOGY

Advances in technology reduce the number of inputs needed to produce a given supply of goods.

Costs go down, profits go up, leading to increased supply.

EXPECTATIONS

If suppliers expect prices to rise in the future, they may store today's supply to reap higher profits later.

NUMBER OF SUPPLIERS

As more people decide to supply a good the market supply increases (Rightward Shift).

INDIVIDUAL AND MARKET SUPPLY CURVES

Market supply refers to quantity of a commodity that all the firms are willing and able to offer for sale at a given price during a given period of time.

The market supply curve is derived by horizontally adding the individual supply curves of each supplier.

FROM INDIVIDUAL SUPPLIES TO A MARKET SUPPLY

Quantities Supplied

ABCDEFGHI

(1)

Price (per DVD)

(2)

Ann's Supply

(5)

MarketSupply

(4)

Charlie'sSupply

0.000.501.001.502.002.503.003.504.00

012345678

001234555

000000022

013579111415

(3)

Barry's Supply

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

FROM INDIVIDUAL SUPPLIES TO A MARKET SUPPLY

Pric

e pe

r D

VD

Charlie Barry Ann

Quantity of DVDs supplied (per week)

Rs. 4.00

3.50

3.00

2.50

2.00

1.50

1.00

0.50

0

I

H

G

F

E

D

C

BA

Market Supply

CA

AGGREGATION OF SUPPLY (I)

AGGREGATION OF SUPPLY (II)

PRICE OF RELATED GOODS OR SERVICES The opportunity cost of producing and

selling any good is the forgone opportunity to produce another good.

If the price of alternate good changes then the opportunity cost of producing changes too!

Example Mc Don selling Hamburgers vs. Salads.

TAXES AND SUBSIDIES

When taxes go up, costs go up, and profits go down, leading suppliers to reduce output.

When government subsidies go up, costs go down, and profits go up, leading suppliers to increase output.

DECREASE IN SUPPLY

INCREASE IN SUPPLY

CHANGE IN SUPPLY VS. A CHANGE IN THE QUANTITY SUPPLIED

Measures the responsiveness of supply due to a change in price.

PRICE ELASTICITY OF SUPPLY

DEF: - THE RATIO BETWEEN % CHANGE IN QUANTITY SUPPLIED

TO THE % CHANGE IN PRICE.

Percentage Change in Quantity Supplied

Percentage Change in PricePES =

Remember:Es = coefficient of price elasticity

QS = Quantity SuppliedP = Price

PES =% ∆QS

% ∆P

PRICE ELASTICITY OF SUPPLY

•PEs > 1 supply is elastic

•PEs < 1 supply is inelastic

•PEs = 1 Unitary Elastic•PEs= ∞ Totally Elastic•PEs= 0 Totally In-Elastic

FIGURE 1. ELASTIC SUPPLY CURVE

PRICE

P1

P2

0Q1 Q2

S

QUANTITY

FIGURE 2. INELASTIC SUPPLY CURVE

PRICE

P1

P2

0Q1 Q2

S

QUANTITY

FIGURE 3. UNITARY SUPPLY CURVE

PRICE

P1

P2

0Q1 Q2

S

QUANTITY

FIGURE 4. PERFECTLY ELASTIC SUPPLY CURVE

PRICE

P1

0

S

QUANTITY

FIGURE 5. PERFECTLY INELASTIC SUPPLY CURVE

PRICE

P1

P2

0

S

QUANTITY

Time Production capacity Producer or chief Stored products

FACTORS THAT AFFECT PRICE ELASTICITY OF SUPPLY

THANK

YOU