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# Chap-3 - PRODUCTION AND COSTS 45 U N I T I I I PRODUCER...

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P RODUCER B EHAVIOUR AND S UPPLY UNIT-II I

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In Chapter 2 we studied the consumer’s behaviour. In Chapters 3 and 4 we will be concerned with the producer’s behaviour. In this chapter in particular, we study important concepts associated with production and costs. A producer or a firm is in business to maximise profit. 1 By definition, profit earned by a firm is equal to its total revenues minus the total costs. As an example, suppose that you are in the business of making hammers, and, during a month, you produce and sell 500 hammers. They are selling at the price of Rs. 20 each. Then the total revenues generated are equal to price × quantity, that is, Rs. 20 × 500 = Rs. 10,000. Producing hammers requires inputs such as labour, building, equipment and raw materials. This is a technological relationship. In turn, inputs have to be paid. The sum total of payments to all inputs is the total cost of production. Let the total cost of making 500 hammers over the month be Rs. 6,500. Then your profit is equal to Rs. 10,000 – Rs. 6,500 = Rs. 3,500. 1 In this chapter and others, we will use the term “profit” or “profits”. Both are correct uses. P RODUCTION AND C OSTS C HAPTER 3 3.1 Production
P RODUCTION AND C OSTS 47 The above example is illustrative of some important linkages. On one hand, the amount produced, or, what is called output , is linked to total revenues in the product market. On the other hand, output is linked to inputs via technology, which is called production function (to be defined in a moment), and, the employment of inputs leads to their payments. This chain links output to costs. output. In section 3.2, we will analyse that between output and payments to inputs. The link between output and revenues will be examined in Chapter 4 (and in Chapter 6 also). 3.1 PRODUCTION 3.1.1 Production Function The most basic concept here is what is called the production function, defined as a technological relationship that tells the maximum output producible from various combinations of inputs. For instance, a firm employs only two factors or inputs, say, labour (measured in hours) and land (in acres), and, Table 3.1 lists some factor combinations and the corresponding output levels. 1 hour of labour and 2 acres of land produce at the most 5 units output, 2 hours of labour and 4 acres of land produce at the most Table 3.1 Production Function Labour Land Output (in hours) (in acres) (in units) A 000 B 125 C2 4 1 1 D3 6 1 8 E4 8 2 4 F 5 10 30 G 6 12 35 H 7 14 40 Fig. 3.1 Linkages These linkages are depicted in fig. 3.1. In Section 3.1, we will study the relationship between inputs and

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I NTRODUCTORY M ICROECONOMICS 48 11 units of output, and so on. It is normally assumed that inputs work to the best of their efficiency. Hence, instead of “maximum” output, we just say output, e.g., 2 hours of labour combined with 4 acres of land produce 11 units of output. 2 Note that the notion of production function is not just confined to two inputs. There can be other inputs like capital, raw material etc. 3 3.1.2 Returns to an Input A production function given in the tabular form such as in Table 3.1 does
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Chap-3 - PRODUCTION AND COSTS 45 U N I T I I I PRODUCER...

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