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 Economics is the study of the
production and consumption of goods
transfer of wealth to produce and obtain those
goods.

Economics explains how people interact within

markets to get what they want or accomplish certain
goals.
Macroeconomics Microeconomics

Macroeconomics Microeconomics focuses

contains broader view by on the actions of
analyzing the economic individuals and
activity of an entire industries, like the
country or the dynamics between
international buyers and sellers,
marketplace. borrowers and lenders.
 A production function is an equation, table or graph, which
specifies the maximum quantity of output, which can be
obtained, with each set of inputs.

Prof. Richard H. Leftwich states that production function refers

to the relationship between inputs and outputs at a given
period.

(Inputs = resources such as land, labor, capital and

organization used by a firm
Outputs = goods or services produced by the firm)
 It is written as Q = F(X1, X2 Xn).
Where Q is the maximum quantity of output and X1, X2, Xn are the
quantities of the various inputs.
If there are only two inputs, labor L and capital K, we write the equation as
Q = F(L,K).

The concept of production function stems from the following two

things:
1. It must be considered with reference to a particular period.
2. It is determined by the state of technology. Any change in technology
may alter output, even when the quantities of inputs remain fixed.
 Total Product : It is the total output or quantity that is produced by a
firm using fixed and variable factors at a given point of time.

Average Product : It is defined as the product produced per unit of

variable input employed when fixed inputs are held constant.
Average Product = (Total Product) / (Variable Inputs Employed)

Marginal Product : It is defined as the change in total product that

comes as a result of a one unit increase in the variable input.
Marginal Product = (dTP) / (dVI)
(where TP is total product and VI is variable inputs. )
 Prof. Marshall stated, An increase in the quantity of a
variable factor added to fixed factors, at the end results
in a less than proportionate increase in the amount of
product, given technical conditions.
 Only one variable factor unit is to be varied while all
other factors should be kept constant
Different inits of variable factor are homogenous
Techniques of production remain constant
The law will hold good only short and a given period
There are possibilities of varying the proportion of
factor inputs.
 The proportion of variable factors is greater than the
quantity of fixed factors. Hence both AP and MP
decline.
Total output diminishes because there is a limit to the
full utilization of indivisible factors and introduction
of specialization. Hence Output declines.
Imperfect suitability of factor inputs is another cause.
Up to certain point substitution is beneficial, once
optimum point is reached, the fixed factors cannot be
compensated by the variable factor.
 The law of returns to scale examines the
relationship between output and the scale of inputs
in the long-run when all the inputs are increased in
the same proportion.
 All the factors of production (such as land, labor and
capital) but organization are variable

The law assumes constant technological state. It

means that there is no change in technology during
the time considered

The market is perfectly competitive

Outputs or returns are measured in physical terms.

 The law of increasing returns

The law of constant returns

The law of decreasing returns

Unit Scale of Production Total Returns Marginal Returns
1 Labor + 2 Acres of 4 (Stage I -
1 4
Land Increasing Returns)
2 Labor + 4 Acres of
2 10 6
Land
3 Labor + 6 Acres of
3 18 8
Land
4 Labor + 8 Acres of 10 (Stage II -
4 28
Land Constant Returns)
5 Labor + 10 Acres of
5 38 10
Land
6 Labor + 12 Acres of
6 48 10
Land
7 Labor + 14 Acres of 8 (Stage III -
7 56
Land Decreasing Returns)
8 Labor + 16 Acres of
8 62 6
Land
Production function
A production function relates
physical output of a production
process to physical inputs or factors
of production
Cost function
The cost-of-production theory of
value is the theory that the price of
an object or condition is determined
by the sum of the cost of the
resources that went into making it.
The cost can comprise any of the
factors of production (including
labor, capital, or land) and taxation.
Total Cost
Total cost in economics includes the
total opportunity cost of each factor
of production as part of its fixed or
variable costs.
Total Product
The total product (or total physical
product) of a variable factor of
production identifies what outputs
are possible using various levels of
the variable input
Average cost
Average cost or unit cost is equal to
total cost divided by the number of
goods produced (the output
quantity, Q). It is also equal to the
sum of average variable costs (total
variable costs divided by Q) plus
average fixed costs (total fixed costs
divided by Q)
Average Product
Average product is the per unit
production of a firm. Conceptually,
it is simply the arithmetic mean of
total product calculated for each
variable input over a whole range of
variable input quantities
Marginal cost
Marginal cost is the change in the total
cost that arises when the quantity
produced has an increment by unit. That
is, it is the cost of producing one more
unit of a good. In general terms,
marginal cost at each level of production
includes any additional costs required to
produce the next unit
Marginal product
The marginal product of an input (factor
of production) is the extra output that
can be produced by using one more unit
of the input (for instance, the difference
in output when a firm's labor usage is
increased from five to six units),
assuming that the quantities of no other
inputs to production change
Law of Variable
Proportions
Short period
Only one factor is varied
The factor ratio remains
changed
There are three stages:
a) Increasing returns to
factor.
b) Diminishing returns to
factor
c) Negative returns to factor
Productions is of variable
type
Law of Returns to
Scale
Long period
All factors varied
The factor ratio remains
unchanged
There are three stages:
a) Increasing returns to scale
b)Decreasing returns to scale
c)Constant returns to scale
Productions is of constant type
 SHORT RUN
Short run is defined as a period when production
can be increased only with increase in variable
factors .

LONG RUN
Long run is defined as a period which allows the
firm to change their sizes and scales to increase
output
 SHORT RUN
The short run as the time horizon over which the scale of
operation is fixed and the only available business decision is
the number of workers to employ.
Quantity of labor is variable but quantity of capital and
production processes are fixed
LONG RUN
The long run as time horizon is needed for a producer to
have flexibility over all relevant production decisions
Long run: Quantity of labor, quantity of capital, and
production processes are all variable
 SHORT RUN
In the short run, firms have already chosen whether
to be in business and at what scale and technology of
production.
The number of firms in an industry is fixed

LONG RUN
In the long run, firms have the flexibility to fully enter
or exit an industry.
The number of firms in an industry is variable since
firms can enter and exit
 SHORT RUN
Firms will produce if the market price at least covers variable
costs, since fixed costs have already been paid and, as such,
don't enter the decision-making process.
Firms' economic profits can be positive, negative or zero.

LONG RUN
Firms will enter a market if the market price is high enough to result
in positive economic profit.
Firms will exit a market if the market price is low enough to result in
negative economic profit.
If all firms have the same costs, firm profits will be zero in the long
run in a competitive market
 It is helpful in understanding clearly the process of
production.

The law tells us that the tendency of diminishing

returns is found in all sectors of the economy .

The law tells us that any increase in the units of

variable factor will lead to increase in the total product
at a diminishing rate.
 This law may not apply universally to all kinds of
productive activities .

This law has been found to operate in agricultural

production more regularly than in industrial
production.

If increasing units of an input are applied to the fixed

factors, the marginal returns to the variable input
decrease eventually.