theory of production and cost in economics pdf

Theory Of Production And Cost In Economics Pdf

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Theory of Production

The theory involves some of the most fundamental principles of economics. These include the relationship between the prices of commodities and the prices or wages or rents of the productive factors used to produce them and also the relationships between the prices of commodities and productive factors, on the one hand, and the quantities of these commodities and productive factors that are produced or used, on the other.

The various decisions a business enterprise makes about its productive activities can be classified into three layers of increasing complexity. The first layer includes decisions about methods of producing a given quantity of the output in a plant of given size and equipment. It involves the problem of what is called short-run cost minimization. The second layer, including the determination of the most profitable quantities of products to produce in any given plant, deals with what is called short-run profit maximization.

The third layer, concerning the determination of the most profitable size and equipment of plant, relates to what is called long-run profit maximization. However much of a commodity a business firm produces, it endeavours to produce it as cheaply as possible.

This task is best understood in terms of what is called the production function , i. It states the amount of product that can be obtained from each and every combination of factors. Here, y denotes the quantity of output. The firm is presumed to use n variable factors of production; that is, factors like hourly paid production workers and raw materials, the quantities of which can be increased or decreased. In the formula the quantity of the first variable factor is denoted by x 1 and so on.

The firm is also presumed to use m fixed factors, or factors like fixed machinery, salaried staff, etc. The available quantity of the first fixed factor is indicated in the formal by k 1 and so on. The entire formula expresses the amount of output that results when specified quantities of factors are employed. It must be noted that though the quantities of the factors determine the quantity of output, the reverse is not true, and as a general rule there will be many combinations of productive factors that could be used to produce the same output.

Finding the cheapest of these is the problem of cost minimization. The cost of production is simply the sum of the costs of all of the various factors. It can be written:. The discussion will deal first with variable cost. The principles involved in selecting the cheapest combination of variable factors can be seen in terms of a simple example. Since there are only two variable factors, this production function can be portrayed graphically in a figure known as an isoquant diagram Figure 1.

In the graph, goldsmith-hours per month are plotted horizontally and the number of feet of gold wire used per month vertically. Each of the curved lines, called an isoquant, will then represent a certain number of necklace chains produced. The data displayed show that goldsmith-hours plus feet of gold wire can produce necklace chains.

But there are other combinations of variable inputs that could also produce necklace chains per month. If the goldsmiths work more carefully and slowly, they can produce chains from feet of wire; but to produce so many chains more goldsmith-hours will be required, perhaps The other two isoquants shown are interpreted similarly.

It is obvious that many more isoquants, in principle an infinite number, could also be drawn. This diagram is a graphic display of the relationships expressed in the production function. Theory of production Article Media Additional Info. Article Contents. Print print Print. Table Of Contents. While every effort has been made to follow citation style rules, there may be some discrepancies.

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External Websites. Author of The Price System. See Article History. Minimization of short-run costs The production function However much of a commodity a business firm produces, it endeavours to produce it as cheaply as possible. It can be written: Get a Britannica Premium subscription and gain access to exclusive content. Subscribe Now. Figure 1: Isoquant diagram of hours of labour and feet of gold wire used per month.

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Theory of Production, Cost and Behaviour of the Firm: A Comprehensive Reformulation

What is a firm? Specialized organization devoted to managing the process of production Produce goods or services Raise resources Manage and coordinate production process. Why do firms exist? Transaction cost Ronald Coase, -specific assets, contractual issues, hold up problems Horizontal and vertical boundaries of firms. Firms objectives 1. Produce maximum output from given level of inputs technical efficiency 2.

Theory of Production, Cost and Behaviour of the Firm: A Comprehensive Reformulation

What is a firm? Specialized organization devoted to managing the process of production Produce goods or services Raise resources Manage and coordinate production process. Why do firms exist? Transaction cost Ronald Coase, -specific assets, contractual issues, hold up problems Horizontal and vertical boundaries of firms. Firms objectives 1.

Long run and short run

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Let us make an in-depth study of the theory of production and the production function in economics. Clark, If, in the short run, its total output remains fixed due to capacity constraints and if it is a price-taker i. Therefore, the only way to maximise profit is to minimise cost. Thus profit maximisation and cost minimisation are the two sides of the same coin. Moreover, supply depends on cost of production. The decision to supply an extra unit depends on the marginal cost of producing that unit.

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Utility and Production pp Cite as.

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