Production and Cost Class 12 Notes Economics Part A Chapter 3

Lesson at a Glance

  • Production: In Economics production means to include any activity which aims at satisfaction of human wants. It converts a commodity or commodities into a different commodity. Production refers to transformation of inputs into output.
  • Factors of Production: It refers to the factor services used in the production or basic services without which production can’t take place. These factors can be classified into Land, Labor, Capital, Entrepreneur.
  • Production Function: It expresses the functional relationship between inputs and corresponding output. In other words, it shows the minimum quantities of various input required to produce a given level of output. Mathematically,
    Q = F (L L1 K O)
    Where Q is quantity produced, L L1 K O are land, labour, capital and organization respectively.
  • Total Product (TP): Total product refers to total quantity of goods produced by a firm during a given period of time with given number of inputs.
    TP = AP X Q or ΣMP
  • Average Product (AP): Average product refers to output per unit of variable input. Average Product is also known as ‘Average Physical Product (APP)’ or ‘Average Return’.
    For example, if total product (TP) is 60 kg. of rice, produced by 10 labour (variable input), then average product will be
    60 ÷ 10 = 6 kg.
  • Marginal Product (MP): Marginal Product refers to addition to total product, when one more unit of variable factor is employed. Marginal Product (MP) is also known as ‘Marginal physical product (MPP)’ or ‘Marginal Return’.
    MPn = TPn – TPn – 1
    MPn = Marginal product of nth unit of variable factor;
    TPn = Total product of n units of variable factor;
    TPn-1 = Total product of (n-1) units of variable factor;
  • Law of Variable proportion: This law states that as more and more units of variable factors are employed on a given quantity of fixed factors, TP first increases at an increasing rate(MP increases) then at a diminishing rate (MP falls but is positive), reaches its maximum(MP is 0), and finally starts falling (MP becomes Negative).
  • Total Cost: In short period, total cost comprises of fixed costs and Variable Cost:
    TC = TFC + TVC
    (TC = Total Cost, TFC = Total Fixed Cost; TVC = Total Variable
  • Total Fixed Cost: Fixed Costs are the sum total of expenditure incurred by the producer on the purchase or hiring of fixed factors of production. These costs do not change with the change in volume of output. Whether the output is zero or maximum, fixed costs remain the same.
  • Total Variable Costs or Prime Costs: Variable Costs are those which are incurred on the use of variable factors. When output changes, these costs also change. As the output increases, these costs also increase and as the output decreases, these costs also decrease. When output is zero, these costs are also zero.
  • Average Total Cost (ATC): Average Cost is the cost per unit of output produced. It is also called unit cost of production.
    Average Fixed Cost (AFC)
    Average fixed cost refers to the per unit fixed cost of production.It is calculated by dividing TFC by total output. AFC = TFC ÷ Q
    Where: AFC = Average Fixed Cost; TFC = Total Fixed Cost; Q
    = Quantity of output
  • Average Variable Cost (AVC): Average variable cost refers to the per unit variable cost of production. It is calculated by dividing TVC by total output.
    AVC = TVC ÷ Q
    Where: AVC = Average Variable Cost; TVC = Total Variable
    Cost; Q = Quantity of output
  • Marginal Cost: Marginal cost is defined as addition made to total variable cost or total cost when one more unit of output is produced. Symbolically,
  • Explicit Cost: It may be defined as money expenditure which is actually incurred by producer to hire the factors of production from outside the firm. These costs are shown in the books of accounts, hence called Accounting Cost.
  • Implicit Cost: It may be defined as the cost of self owned factors of production. For example, Imputed rent of owner occupied building, interest of owner’s capital, wages of entrepreneur. These costs are also called non accounting cost or opportunity cost of owned factors.
    (i) For an accountant, Cost = Explicit Cost
    (ii) For an Economist, Cost = Explicit Cost + Implicit Cost + Normal profits
  • Opportunity Cost: Opportunity cost is opportunity lost. It is the next best alternative sacrificed by a factor of production in order to avail of a given opportunity. For example, If a person invests his money in the business, he had to sacrifice the interest he could earn by keeping that money in the bank.This is opportunity cost.
  • Money Cost vs Real Cost: That cost which is capable of being measured in terms of money is called money cost. Real cost refers to the cost which is subjective and can’t be measured in terms of money. It may be defined as all those pains, toils, discomforts, disutility and sacrifices made by a factor of production to contribute her services in the production process.
  • Private Cost vs Social Cost: Private cost refers to the cost borne by the organization. It includes money/explicit cost. Social cost refers to the cost which is borne by the society and can’t be measured in terms of money. For example, polluting environment

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