Economics Three

7/30/2019 Economics Three

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PRODUCTION ECONOMICS

Jibgar Joshi


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Explicit costs of production Implicit costs Profits

Accounting profit and pure economic profits Fixed inputs Variable inputs Marginal physical product

Law of diminishing returns Economies of scale Diseconomies of scale

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Explicit costs and Implicit costs

Explicit costs: opportunity costs that take the form ofpayments to outside suppliers, workers and others

who do not share the ownership of the firm. Implicit costs: opportunity costs of using resources

owned by the owners of the firm.


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Profit

Profit means the difference between a firm's total revenues and

its total costs (implicit as well as explicit costs).Business:Total revenue minus total costs during a specified time periodEconomics:

Excess over returns to capital, land and labourExcess over interest, rent and wages. Accounting profit: total revenue minus explicit costs Pure economic profit: accounting profit minus implicit

costs.


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Profit is mistaken as the sum of implicit wages ofmanagers/owners, rent on land owned by the firm andinterest on the capital invested by the owners of the

firm.In conditions of competitive equilibrium, pure profit

would not exist.

Any profit will lead to an increase in output that will

lead to a fall in price and the profit will be squeezedout.

Entrepreneurial profit, windfall profit, monopoly profit.

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Fixed inputs: that can not be changed in a short time. Variable inputs: that can easily be varied in a short

time in order to increase or decrease the output.

Marginal physical product: the amount of outputexpressed in physical units produced by each addedinput of one variable input, other things being equal.

Law of diminishing returns: The principle that as onevariable input is increased, with all others remaining

fixed, a point will be reached beyond which themarginal physical product of the variable input beginsto decrease.

Marginal cost: the increase in cost required to

increase the output of some good or service by one

unit.


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Economies of scale

A phenomenon said to occur whenever long runaverage cost decreases as output increases.

Diseconomies of scale: a phenomenon said to occur

whenever long run average cost increases as outputincreases. Constant returns to scale: no economies of scale or

diseconomies of scale.


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Opportunity or social costs

The social cost of a factor of production is its cost in thebest alternative use. It is the opportunity foregone

Cost to the individual Cost to the society as a whole Private good vs. social/public goodBy definition, a public good can be enjoyed without

diminishing its supply. Others cannot be excludedfrom its use and it is not traded. As a result of being

non-rivalry, demand for public good is collective; it isthe sum of the separate demands of individuals forthe good.


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Market and Valuation

Market: where buyers and sellers meet, transmitsinformation, provide incentives, and distributeincome.

Market imperfections Market failures Market vs. public institutions Monetary values for comparison

Social equity, the urban poor Use value vs. exchange value Private goods vs. public goods Welfare goods vs. market goods


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Market Failure

Although markets can be made to achieve efficientallocation, they are unable to do so. They fail to leadthe economic process towards the social optimum. Thisis described as market failure. It can occur whenmarkets do not exist or when they fail to communicateinformation. It can also occur due to restrictions in themarket operation and lack of institutions or regulations.

Activities can impose losses or gains on the welfareof the people other than those engaged in the activities.If these losses or gains go uncompensated or unpaidfor, they are described as externalities. It is not easy tovalue them and enter into market prices. As a result,they are not accounted for in market-based allocation.This leads to a resource allocation, which is less thanthe social optimum. This is also a cause of marketfailure.


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Internal and external economics and urban growth

Internal economics Efficient production system Equitable distribution Convergence of private goods and public goods Ability to satisfy needs over time.External economics Competitive markets Capital stock Labour deploymentUrban growth Use of resources outside the urban boundary Primacy and economic domination Economic base

Competitiveness


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Laws of demand and supply

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Supply

The amount of a commodity that a firm wishes to sell is called

the quantity supplied. It is a flow expressed as so much perperiod of time.

It depends on:

Commoditys own price

The prices of other commodities The costs of factors of production The goals of the firm The state of technologyIt increases if the price of the commodity increases.

Quantity supplied is assumed to increase as the price of the

commodity increases, ceteris paribus, a movement along a

supply curve indicates a change in the quantity supplied inres onse to a chan e in rice.


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Demand

The amount of a commodity that households wish topurchase is called the quantity demanded. It is a flowexpressed as so much per period of time. This quantity isdetermined by the commoditys own price. The prices ofrelated commodities, average household income, tastes,the distribution of income among households and thesize of the population. The quantity of demand is

determined by: The commoditys own price The price of the related commodities Average household income

Tastes The distribution of income among households The size of the population


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Quantity demanded is assumed to increase as the price

of the commodity falls, ceteris paribus. The

relationship between quantity demanded and price is

presented graphically by a demand curve that shows

how much will be demanded at each market price. Amovement along a demand curve indicates a change

in the quantity demanded in response to a change in

the price of the commodity.

A rise in demand raises both equilibrium price andquantity; a fall in demand lowers equilibriumquantity but raises equilibrium price.

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Demand and supply curve

Using the method of comparative statistics, the effectsof a shift in either demand or supply can bedetermined.

The demand curve shifts to the right (an increase indemand) if

Average income rises The prices of the substitute rises A price of a complement falls

Population rises

There is a change in the taste in favour of the productThe opposite changes shift the demand curve to the left. A

shift of a demand curve represents a change in thequantity demanded in each price and is referred to as achange in demand.


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The supply curve shifts to the right (an increase insupply) if

the prices of other commodities fall The costs of producing the commodity fall Producers become more willing to produce the

commodity

The opposite changes shift the supply curve to the left.A shift of a supply curve represents a change in thequantity supplied in each price and is referred to as a

change in supply.

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Price determination

Price theory is most simply explained against abackdrop of a constant price level. Price changesdiscussed in the theory are changes relative to theaverage level of all prices. In an inflationary period, a

rise in the relative price of one commodity means thatits price rises more than does the price level. A fall inits relative price means that its price rises by less thandoes the price level.

Price is assumed to rise when there is a shortage and to

fall when there is a surplus. Thus the actual marketprice will be pushed toward the equilibrium price,and when it is reached, there will be neither shortagenor surplus and price will not change until either thesupply curve or the demand curve shifts.


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Equilibrium Price

Is the one at which the quantity demanded equals thequantity supplied. At any price below the equilibriumthere will be excess demand while at any price abovethe equilibrium there will be excess supply. Graphicallyequilibrium occurs where demand and supply curves

intersect.Price is assumed to rise when there is a shortage and tofall when there is a surplus. Actual market price will be

pushed towards the equilibrium. When it is reachedthere will be neither shortage nor surplus. Price will not

change until the supply or the demand curve changes A rise in demand raises both e-price and quantity and afall lowers both. A rise in supply raises e-quantity andlowers e- price. A fall in supply lowers e-quantity andraises e- price. These are the laws of supply anddemand.


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Price

(Rs.)

Quantity of

Demand Supply

14 1 6

10 2 5

7 3 4

5 4 3

3 5 32 6 1


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Demand and Supply Curve

02

4

6

810

12

14

16

1 2 3 4 5 6

Demand/Supply

Price(Rs.)

Supply

Demand

Economics Three

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