What is supply?

Supply refers to the quantity

of a commodity which
producers or sellers are willing
to produce and offer for sale at
a particular price, in a given
market, at a purticular period
of time
 The three important aspects of
supply are.
Supply is a desired quantity
Supply is always explained with
reference to price
Supply is a flow variable
 Stock and flow concepts
Stock variable Flow variable
It is an economic It is an economic
variable which can be variable which can be
measured at a point of measured at a period
time. of time.
Eg: population, water Eg: National income,
in a reservoir, goods in water in a river, sales
a warehouse. etc.
 Individual supply

Individual supply refers to the quantity of a

commodity which a firm is willing to produce
and offer for sale at a particular price during a
specified period.
 Supply Curve

The supply curve has a positive slope, consistent

with the law of supply.
 Market supply
Market supply refers to the quantity
that all the producers are willing to
produce and offer for sale at a
particular price during a specified
period.
It is the sum total of individual
supply
Difference between stock and supply
Stock Supply
Stock is the total Supply is that part of
quantity of a stock which the
commodity available producers are willing
with the producers to bring to the market
which is ready for and offer for sale at a
sale. particular price.
Stock is not a part of Supply depends on
supply stock.
 Determinants of supply

Price of the commodity:

When price increases,
supply also increases
because it motivate the firm
to supply more in order to
get more profit. When price
decreases, smaller quantity
will be supplied as profit
decreases.
 Determinants of supply

Goals of the firm: The goals of

the firm may be profit
maximization"," sales
maximization" or risk
minimization". If the aim is
sales maximization, they will
produce and supply more and
if the aim is risk minimization,
they will supply less.
 Determinants of supply
Input prices:
If the prices of inputs and factors
used in production such as raw
materials, labour, machine etc. are
high, the cost of production will be
high. Higher cost of production, at
the given price, reduces the profit
margin and will persuade the
producer to produce and supply
less.
 Determinants of supply
Prices of related commodities:
Producers always have the tendency of shifting from
the production of one commodity to another
commodity. If the prices of another commodity
increases, especially substitute goods, producers will
find it more profitable to produce that commodity by
reducing the production of the existing commodity.
 Determinants of supply
Techniques of production:
An improvement in the technique
of production reduces the cost
of production and increases
profit margin. Increased
profitability motivates the
producers to increase the
supply.
 Determinants of supply
Nature of the market:
A monopolist firm will like to restrict supply so as to
raise the market price and as a result supply decreases.
But in a competitive market there will be no tendency
to restrict output because each firm wants to sell more
to earn more profit.
 Determinants of supply
The policy of taxation and subsidies:
The taxation policy of the government also
influences the supply of a commodity. For eg> If
government increases the sales tax and excise
duty, it increases the cost of production, which
induces the producer to reduce the supply as the
profit margin decreases.
 Determinants of supply
Expectations about future prices:
If a producer expects an increase in market price in
future, then they will supply less today and hoard
the stock to sell at a high price in future and vice
versa.
 Determinants of supply
Natural factors:
In case of agricultural products, the
natural factors like flood, draught
etc. adversely affect the supply of
commodities. On the other hand
favourable climatic conditions
may help in increasing the supply
of agricultural commodities.
 Determinants of supply
Agreement among producers:
Some times producers may form associations and enter
into some agreement to restrict the supply of a
commodity to earn large profits. They will create
artificial scarcity of the commodities and as a
consequence, the supply will decrease.
 Determinants of demand
Availability of transport
and communication
facilities:
An improvement in
transport and
communication facilities
will expand the size of
market and this will
motivate the producers to
produce and supply more.
 Production, Production
Function

Production in the Short run

 Production
Production process involves the transformation
of inputs into output. The inputs could be land,
labour, capital, entrepreneurship etc. and the
output could be goods or services.

An entrepreneur must put together resources --

land, labour, capital -- and produce a product
people will be willing and able to purchase
In a production process managers take four
types of decisions:
(a) whether to produce or not,
(b) how much output to produce,
(c) what input combination to use,
(d) what type of technology to use.
 PRODUCTION FUNCTION
States the relationship between inputs and outputs

A production function is the functional

relationship between inputs and output. It
shows the maximum output which can be
obtained for a given combination of inputs.
 It expresses the technological relationship between inputs
and output of a product

In general, we can represent the production function for a

firm as:Q = f (x1, x2, .,xn)

Where Q is the maximum quantity of output, x1, x2, .,xn

are the quantities of various inputs, and f stands for
functional relationship between inputs and output. For the
sake of clarity, let us restrict our attention to only one
product produced using either one input or two inputs. If
there are only two inputs, capital (K) and labour (L), we
write the production function as = f (L, K)
 Inputs the factors of production classified as:
Land all natural resources of the earth
Price paid to acquire land = Rent

Labour all physical and mental human effort

involved in production
Price paid to labour = Wages

Capital buildings, machinery and equipment

not used for its own sake but for the contribution
it makes to production
Price paid for capital = Interest
 Inputs Process Output

Land
Product or
Labour service
generated
value added
Capital
PRODUCTION IN THE SHORT
RUN
Short run is a period just short enough that
at least one resource (input-industrial plant,
machines) cannot be changed -- is fixed or
inelastic. thus in the short run production of
a commodity can be increased by increasing
the use of only variable inputs like labour
and raw materials.
 Plant size is
Short Run fixed, labor is
variable
 Definition of Short Run

Short run is a period of time over which at least one factor

must remain fixed. For most of the firms, the fixed resource or
factors which cannot be increased to meet the rising demand
of the good is capital i.e., plant and machinery.
Short run, then, is a period of time over which output can be
changed by adjusting the quantities of resources such as labour,
raw material, fuel but the size or scale of the firm remains fixed.
 Analysis of Production Function:
Short Run
In the short run at least one factor fixed in supply
but all other factors capable of being changed
Reflects ways in which firms respond to changes
in output (demand)
Can increase or decrease output using more or less
of some factors but some likely to be easier
to change than others
Increase in total capacity only possible
in the long run
Production Function Short Run

In times of rising
sales (demand)
firms can increase
labour and capital
but only up to a
certain level they
will be limited by
the amount of
space. In this
example, land is
the fixed factor
which cannot be
altered in the short
run.
Production Function Short Run

If demand slows
down, the firm can
reduce its variable
factors in this
example it reduces
its labour and
capital but again,
land is the factor
which stays fixed.
Production Function Short Run

If demand slows
down, the firm can
reduce its variable
factors in this
example, it
reduces its labour
and capital but
again, land is the
factor which stays
fixed.
Production Function Short Run
Production Function Short Run

Unit of capital No Of labours Total out put AP MP

1 1 3 3 3

1 2 8 4 5

1 3 12 4 4

1 4 14 3.5 2

1 5 14 2.8 0

1 6 12 2 -2
ISOQUANTS
 Isoquants and its Properties.

Contents:-
Production & Production function.
Isoquants.
Types of isoquants.
Properties of isoquants.
Isocosts & equilibrium of producers.
 Production

What is production?

according to production manager

according to economist
 Production Function

The relationship between the inputs to the

production process and the resulting output
is described by a production function.

P(A)= f(L,K)
 Fixed Inputs
A Fixed input is defined as one whose
quantity cannot be changed instantaneously
in response to changes in market conditions
requiring an immediate change in output.

Example-
Buildings, major capital equipment and
managerial personnel.
 Variable Inputs
Variable input is one whose quantity can be
changed readily when market conditions
suggest that an immediate change in output
is beneficial to the producer.

Example-
Raw materials and labour services.
 Short Run
Short run is defined as that period of time in
which quantity of one or more inputs
remains fixed irrespective of the volume of
output.

Example-
Using more of raw material and employing
an increased number of workers with the
existing plant and equipment.
 Long Run
Long run refers to that period of time in
which all inputs are variable.

Example-
Installation of additional machine and
employing more workers.
 What are Isoquants?

An isoquant is the locus of all the combinations

of two factors of production that yield the
same level of output.
Isoquant Table showing combinations of Labour and Capital Producing
100 units of X

Processes Units of Units of

Labour Capital
1 1 10
2 2 7
3 3 5
4 4 4
5 6 3
6 9 2
 Convex isoquant
K

4 4

2
XO
2 4
Y L
 Types of Isoquants

Linear Isoquant

Input- Output Isoquant

 Linear Isoquant
Y
Y

O X

A case of a perfect substitutability of production factors

Isoquants shapes of a straight line sloping downwards from
left to right
 Input- Output Isoquant
Y

Here factors of production are not substitutes but their coefficients are
fixed
Shape of it is right angled or L shaped
Also known as Leontief isoquant
 Isoquant Map
Output varies as the factor input change.
Nearer the point of origin lower the production.
Complete set of isoquants for the producers
Y

O X
 Isoquants nearer to the point of origin
represent relatively lower level of
 Assumptions:-

There are only two factors or inputs of

production.

Divisible into small units.

Technical conditions.
 Characteristics or Properties of Isoquants

Isoquants are negatively sloped.

A higher represents a larger output.

No two isoquants intersect or touch each other.

Isoquants are convex to the origin.

 Isoquants are negatively sloped

Isoquants having positively sloped segments

 A higher represents a larger output

Two isoquants representing different output levels

 No two isoquants intersect or touch each other

No two isoquants intersect one another

 Isoquants are convex to the origin

Convexity of an isoquant
 Isocosts
Various combinations of
i/p that may be purchased
for given amt of exp.
Isocosts is ratio of change
of capital to labour.
Line close to origin
indicates lower cost
outlay.
 Max o/p for a given cost

AIM

Why Iso-quants & Iso-cost line ?

Position of the Producer.

Conditions for least cost comb.

Slope of IQ - MRTS

Slope of IC Price factor

 Minimisation of cost for given level of o/p
AIM
Position of the Producer.
Condition for equilibrium
same.
MRTS = factor price ratio
 Limitations

Merely describes i/p substitution method

but doesnt explain it.
Exp. may summarize but unable to explain
shape or posn.
Limited to 2 or 3 i/ps.
Uninformative about new i/ps.
EXPANSION PATH
 Concepts:
In economics, an expansion path is a line
connecting optimal input combinations as the
scale of production expands.

A producer seeking to produce the most units

of a product in the cheapest possible way
attempts to increase production along the
expansion path.
 Economists Alfred Stonier and Douglas
Hague defined expansion path as, that line
which reflects least cost method of producing
different levels of output, when factors prices
remains constant.
The Firms Expansion Path
The expansion path does not have to be
a straight line.

The expansion path does not have to be

upward sloping.
 Y Firms Expansion Path
1 E
41
31
21 L Expansion
A
11 Path
Capital (K)

09
C
8 J
7 I Optimal inputs
6 combination
5 H 14 III
4 Q
3 G M
K 12Q
2 10Q II
1 D BI F
X
0 2 6 8 1 1
4 1
Labour (L)
 At the points of tangency between
isoquants and iso-cost lines, the slope of
isoquant (MRTS) is equal to the slope of
the iso-cost line. Where,
w = wage rate of labour
i.e. Slope of iso-cost line = -w/r r = rate of capital
Slope of isoquant (MRTS) = -MPL/MPK
Optimal inputs combination is:
MPL w
MPK r
we get:
MPL MPK
w r
 Conclusion
Expansion path gives the least cost input
combinations for every level of output.

The point on an expansion path occur when

iso-cost line and isoquant are tangent.

At the points of tangency between isoquants

and iso-cost lines, the slope of isoquant
(MRTS) is equal to the slope of the iso-cost
line.
The Cobb-Douglas Production
Function

Y=
AK L (1- )
 History
Developed by Paul
Douglas and C. W.
Cobb in the 1930s
 History
Developed by Paul
Douglas and C. W.
Cobb in the 1930s
Douglas went on to
be professor at
Chicago and U.S.
Senator
Cobb - ??
 The General Problem
An increase in a nations capital stock or
labor force means more output.
Is there a mathematical formula that relates
capital, labor and output?
 The General Form

1
Yt At K t Lt
Increasing Capital

Yo AKo L 1
o

Y A(2 K o ) L 1
o
 Increasing Capital

Yo AK o L 1
o

Y A(2 K o ) L 1
o


2 AK o L 1
o 2 Yo
 Increasing Capital

Yo AK o L 1
o

Y A(2 K o ) L 1
o


2 AK o L 1
o 2 Yo

Diminishing returns to proportion

 Increasing Labor

Yo AK o L 1
o

Y AK o (2 Lo ) 1
 Increasing Labor

Yo AKo L 1
o

Y AKo (2 Lo ) 1

21
AKo L 1
o 2 Yo1
 Increasing Labor

Yo AKo L 1
o

Y AKo (2 Lo ) 1

21
AKo L 1
o 2 Yo 1

Diminishing returns to proportion

 Increasing Both

Yo AK o L
1
o

Y A(2 K o ) (2 Lo )
1
 Increasing Both

Yo AK o L 1
o

Y A(2 K o ) (2 Lo )
1


2 AK o L 1
o 2 Yo
 Increasing Both

Yo AK o L 1
o

Y A(2 K o ) (2 Lo ) 1

2 AK o L 1
o 2 Yo
Constant returns to scale
 Substitution

Yo AKo L 1
o

Y A(2K o ) ( xLo ) 1
Yo

Capital and Labor Can be Substituted

 An Illustration

Yt At K L 1/ 2
t
1/ 2
t
 An Illustration

Y AK L 1/ 2 1/ 2
 An Illustration

Y A KL
 An Illustration
A =3 L =10

Y A KL
K =10
 An Illustration

Y 3 (10)(10) 3 100 30
 Doubling Capital

Y 3 (20)(10) 3 200
30 2 42
 Constant Returns to Scale

Y 3 (20)(20) 3 400 60
 Substitution

Y 3 (20)( x) 30
x5
 Estimation

Yt At K t L
1
t

log( Yt ) log( At ) log( K t )

(1 ) log( Lt )
 Estimation

log( Yt ) C t 1 log( K t )
2 log( Lt ) t
 Estimation

log( Yt ) 1 log( K t )
2 log( Lt ) t

Statistical issues abound!

Best Estimate

3
 Factor Payments
= % of Income going to owners
of capital
1- = % of Income going to workers
 How well does it work?

Yt At K t Lt

You cant beat something

with nothing
The Cobb-Douglas
Production Function
CES Production Function

K
%
L
w
%
r
CES Production Function

Suppose 10% increase in
K
%leads
wage rate to 10%
L
increase in capital
ratio. = 1.
labor

w
%
r
CES Production Function

Suppose 10% increase in
K
rateleads
wage % to 5%
L
increase in capital
ratio. = .
labor

w
%
r
CES Production Function

In the Cobb-Douglas
K
%Function,
Production
=1.L

w
%
r
 CES Production Function

The CES allows for a different elasticity of

substitution.
Little gained.
Leontief Production Function
K

L
 Leontief Production Function
K
K = aY
L = bY

L
 Leontief Production Function
K
K = aY
L = bY

L
 Leontief Production Function
K
K = aY
L = bY

=0

L
 Leontief Production Function
K
K = aY
L = bY

Doesnt work. We
can and do
substitute labor for
capital all the time
L
 Other Factors?

Yt At K t Lt LND
1
t
 And in Conclusion

1
Yt At K t Lt
Cost Concepts
Cost Concept:
It is used for analyzing the cost of a
project in short and long run.
Types of Cost:
Total fixed costs (TFC)
Average fixed costs (AFC)
Total variable costs (TVC)
Average variable cost (AVC)
Total cost (TC)
Average total cost (ATC)
Marginal cost (MC)
Fixed Costs(FC)
Fixed Cost denotes the costs which do not
vary with the level of production. FC is
independent of output.
Eg: Depreciation, Interest Rate, Rent, Taxes

Total fixed cost (TFC):

All costs associated with the fixed input.

Average fixed cost per unit of output:

AFC = TFC /Output
Variable Costs(VC)
Variable Costs is the rest of total cost, the part that
varies as you produce more or less. It depends
on Output.
Eg: Increase of output with labour.

Total variable cost (TVC):

All costs associated with the variable
input.
Average variable cost- cost per unit of output:
AVC = TVC/ Output
Total costs(TC)
The sum of total fixed costs and
total variable costs:

TC = TFC + TVC

Average Total Cost

Average total cost per unit of output:

ATC =AFC + AVC

ATC = TC/ Output
Marginal Costs

The additional cost incurred from

producing an additional unit of output:

MC = TC
Output
MC = TVC
Output
Typical Total Cost Curves

TVC,TC is always increasing:

First at a decreasing rate.
Then at an increasing rate
Typical Average & Marginal Cost
Curves
 AFC is always MC is generally
declining at a increasing.
decreasing rate. MC crosses ATC and
ATC and AVC decline AVC at their minimum
at first, reach a point.
minimum, then If MC is below the average
increase at higher value:
levels of output. Average value will be
The difference decreasing.
between ATC and AVC If MC is above the average
value:
is equal to AFC.
Average value will be
increasing.
Production Rules for the Short-Run
1.If expected selling price < minimum AVC (which
implies TR < TVC):
A loss cannot be avoided.
Minimize loss by not producing.
The loss will be equal to TFC.

2.If expected selling price < minimum ATC but >

minimum AVC:
(which implies TR > TVC but < TC)
A loss cannot be avoided.
Minimize loss by producing where MR = MC.
The loss will be between 0 and TFC.
 Contd
3.If expected selling price > minimum ATC (which
implies TR > TC):
A profit can be made.
Maximize profit by producing where:
MR = MC
Short Run Production Decisions

SP SP
Long Run Costs Curve:

All costs are variable in the long run.

There is only AVC in LR, since all
factors are variable.
It is also called as Planning Curve or
Envelope or scale curve.
Production Rules for the Long-Run

1.If selling price > ATC (or TR > TC):

Continue to produce.
Maximize profit by producing where
MR = MC.
2.If selling price < ATC (or TR < TC):
There will be a continual loss.
Sell the fixed assets to eliminate fixed costs.
Reinvest money is a more profitable
alternative.
Long Run Cost Curve

Economies of scale M Diseconomies of scale

M-optimum level of produ

Economies of Scale:
Economies of scale are the cost
advantages that a firm obtains due to
expansion. Diseconomies is the opposite.
Two types:
1. Pecuniary Economies of Scale:
Paying low prices because of buying
in large Quantity.
2.Real Economies of Scale:
Refers to reduction in physical
quantities of input , per unit of output
when the size of the firm increases, as a
result input cost minimized.
Diseconomies:
1.Internal Economies: It is a condition
which brings about a decrease in LRAC of
the firm because of changes happening
within the firm.
e.g.As a company's scope increases, it may
have to distribute its goods and services in
progressively more dispersed areas. This
can actually increase average costs
resulting in diseconomies of scale.
2.External Economies:
It is a condition which brings about
a decrease in LRAC of the firm because
of changes happening outside the firm.
E.g. Taxation policies of Gov
 COST- OUTPUT
RELATIONSHIP
Cost- output relationship has two aspects
1. Cost output relationship in short run
2. Cost output relationship in long run
The short run is a period which does not permit alterations in
the fixed equipment and in the size of the organization.
The long run is a period in which there is sufficient time to
alter the equipment and the size of the organization . output
can be increased without any limits being placed by the fixed
factors of production.
COST OUTPUT RELATIONSHIP IN
SHORT RUN
Short run may be studied in terms of
Average fixed cost
Average variable cost
Average total cost
Average fixed cost
The greater the output ,the lower the fixed cost per unit
i.e. the average fixed cost . Total fixed cost remain the
same and do not change with a change in output.
 Average variable cost
The average variable cost will first fall and then rise as
more and more units are produced in a given place.
E.g. electricity charge , labour cost.etc.
 AVERAGE TOTAL COST
Average total cost , also known as average cost ,
would decline first and then rise upwards.
Average cost consists of average fixed cost plus
average variable cost
Average fixed cost continues to fall with an
increase in output while average variable cost first
declines and then rises.
When the rise in AVC is more than the drop in
average fixed cost that the average total cost will
show a rise.
COST - OUTPUT RELATION IN LONG
RUN
 Long run period enables the producers to change
all the factor and will be able to meet the
demand by adjusting supply . change in fixed
factors like building , machinery , managerial
staff etc.
All factors became variable in the long run
In the long run we have 3 costs i.e. total cost. ,
Average cost and Marginal cost.
Total cost TC =TFC +TVC
Average cost AC=TC/output
Marginal cost MC =change in TC as a result of
change in output by one unit
When all the short run situations are combined
, it forms the long run industry.
During the short run . Demand is less and the
plants capacity is limited .when demand rises
,the capacity of the plant is expanded .
When short run average cost curves of all such
situations are depicted , we can derive a long
run cost curve out of that.
We can make a long run cost curve by joining
the tangency points of all short run curves.
We use long run costs to decide scale issues , for
example mergers.
In the long run , we can build any size factory we
wish , based on anticipated demand , profits , and
other considerations.
Once the plant is built , we move to the short run .
Therefore , it is important to forecast the
anticipated demand . Too small a factory and
marginal costs will be high as the factory is
stretched to over produce.
Conversely too large a factory results in large
fixed costs and low profitability
 COST
FUNCTION
COST FUNCTION IN SHORT
RUN

Cost function may be defined as the

relationship between costs of a
product and output.

C = F [Q]
 SHORT
RUN COST
COST

LONG
RUN COST
 SHORT RUN COST
FUNCTION

An analysis in which certain

factors are assumed to be fixed
during the period analyzed.

In short run output can be

increased or decreased by changing
only the variable factors.
 Fixed cost

Short +
Variable cost
run cost

Total
= cost
SHORT RUN FIXED COST

Fixed cost are those cost which do

not change with changes in output.

Fixed cost are otherwise called

supplementary cost or over head
costs.

Eg ; Rent on land and building ,

Insurance charges, Interest on
SHORT RUN VARIABLE COST

Variable cost are those costs which

changes with changes in output.

Variable cost are also called prime

cost.

Eg; cost of raw materials, cost of

power in production, wages of
workers.
 SHORT RUN TOTAL
COST
Total cost is defined as the Total actual cost
that must be incurred to produce a given
quantity of output.

Fixed cost and variable cost are formally

called Total fixed cost and Total Variable cost.

TC = TFC + TVC
UNITS OF OUTPUT TFC TVC TC
[Rs.] [Rs.] [Rs.]

0 60 60 -60 = 0 60

1 60 100 -60 = 40 100

2 60 120 60 = 60 120

3 60 70 130

4 60 100 160

5 60 160 220

6 60 300 360
SHORT RUN TOTAL COST
CURVE
.............

TFC being fixed at Rs.60, remains the same at

all levels of output . Thus, the TFC- curve is a
straight line parallel to the x-axis.

TVC curve starts from the origin at zero

output . It move upwards from left to right.

The shape of TC curve is the same as TVC-

curve.
SHORT RUN AVERAGE
COST
AVERAGE FIXED
COST
SHORT
RUN
AVERAGE AVERAGE
VARIABLE COST
COST

AVERAGE
FIXED COST
AVERAGE FIXED COSTS

AFC is the per unit fixed cost of

producing a commodity. It is
obtained by dividing the total
fixed cost by the quantity of
output [Q].

AFC = TFC

Q
AVERAGE VARIABLE COST

AVC is the per unit variable cost

of producing a commodity . It is
obtained by dividing the total
variable cost by the quantity of
output. AVC = TVC

Q
AVERAGE TOTAL COST

AC is the sum total of AFC and AVC.

AC = TC

Q
SHORT RUN AVERAGE
MARGINAL COST CURVE

MARGINAL COST ; Marginal cost is

the addition to total cost by the
production of an additional unit of
output.

MCn = TCn - TCn-1

;w
Units of TFC TVC TC AFC AVC ATC MC
productio [Rs] [Rs] [Rs] [Rs] [Rs] [Rs] [Rs]
n
O 60 0 60 - - - -

1 60 40 10 60 40 100 40

2 60 60 120 30 30 60 20

3 60 70 130 20 23.3 43.3 10

4 60 100 160 15 25 40 30

5 60 160 220 12 32 44 60

6 60 300 360 10 50 60 140

SHORT RUN AVERAGE
MARGINAL CURVES
 The short run MC curve will at first
decline and the ATC and AVC at their
minimum points.

The AVC curve will go down , and then

go up.

AFC curve will decline as additional

units are produced , and continue to
decline.

ATC curve initially will decline as the

fixed cost are spread over a large
number of units , but will go up as MC
increase due to the law of diminishing
returns.
THANK YOU