Production and Cost Analysis: Production Function, Returns, Cost Concepts and Cost Curves Questions

Question 1

Define production function.

Accepted Answer

A **production function** shows the functional relationship between inputs (land, labor, capital, technology) and the output produced.

Question 2

What is total product (TP)?

Accepted Answer

**Total product (TP)** is the total output produced by a given amount of input (e.g., labor) in a period.

Question 3

Define marginal product (MP).

Accepted Answer

**Marginal product (MP)** is the additional output obtained by employing one extra unit of a variable input, keeping other inputs constant.

Question 4

What is total cost (TC)?

Accepted Answer

**Total cost (TC)** is the sum of total fixed cost and total variable cost: **TC = TFC + TVC**.

Question 5

What is average fixed cost (AFC)?

Accepted Answer

**Average fixed cost (AFC)** is fixed cost per unit of output: **AFC = TFC / Q**.

Question 6

State the law of variable proportions (law of diminishing returns).

Accepted Answer

When more units of a variable factor are applied to a fixed factor, output increases initially but eventually **marginal product diminishes** and may become negative.

Question 7

Explain TP, AP and MP with formulas (brief).

Accepted Answer

For a variable input like labor (L):
- **TP (Total Product)**: total output produced.
- **AP (Average Product)**: output per unit input, **AP = TP / L**.
- **MP (Marginal Product)**: extra output from one more unit input, **MP = ΔTP / ΔL**.

Thus, TP is total, AP is per-unit average, and MP is additional output.

Question 8

Explain the law of variable proportions and why MP diminishes (any three reasons).

Accepted Answer

The **law of variable proportions** states that when a variable factor is increased with a fixed factor, output rises at first but later **MP falls**.

Reasons for diminishing MP (any three):
- the **fixed factor** becomes a constraint (limited space/machines).
- **factor indivisibility** and overcrowding reduce efficiency.
- coordination and management problems increase with too many workers.

Hence, after optimum use of fixed input, additional labor adds less output.

Question 9

Explain stages of production (Stage I, II, III) and identify the rational stage.

Accepted Answer

Stages of production (short run):
- **Stage I**: TP increases, AP rises; fixed factor underutilized.
- **Stage II**: TP increases at diminishing rate; MP is positive but falling; **rational stage** for operation.
- **Stage III**: TP falls; MP becomes negative due to overcrowding.

Thus, firms operate in **Stage II** because resources are used efficiently and MP is still positive.

Question 10

Explain TFC, TVC and TC with a simple example.

Accepted Answer

**TFC (Total Fixed Cost)** does not change with output (rent, salaried staff).
**TVC (Total Variable Cost)** changes with output (raw materials, power).
**TC (Total Cost)** is the total: **TC = TFC + TVC**.

Example:
- If monthly rent is ₹10,000 (fixed) and raw material cost is ₹50 per unit (variable):
  - At Q=100 units, TVC=₹5,000 and TC=₹15,000.
  - At Q=200 units, TVC=₹10,000 and TC=₹20,000.

Hence, fixed cost stays same but variable and total costs rise with output.

Question 11

Explain relationship between MC and AC/AVC (any three points).

Accepted Answer

Relationship between **MC** and **AC/AVC**:
- If **MC < AC**, AC falls.
- If **MC = AC**, AC is at minimum.
- If **MC > AC**, AC rises.
- Similarly, MC cuts **AVC** at AVC’s minimum point.

Thus, MC acts like a guide that pulls AC/AVC down when it is below them and pushes them up when it is above.

Question 12

Differentiate between explicit cost and implicit cost with examples.

Accepted Answer

Difference between **explicit** and **implicit** costs:
- **Explicit cost**: actual cash payment made by the firm (recorded in accounts).
  - Examples: wages paid, rent paid, electricity bill, raw material payment.
- **Implicit cost**: imputed cost of using owned resources (not a cash payment).
  - Examples: owner’s salary for his own work, rent that could be earned from own building used in business.

Thus, explicit costs are out-of-pocket costs, while implicit costs represent opportunity cost of owned resources.

Question 13

Explain production function and the law of variable proportions with a flowchart and key points (exam-style).

Accepted Answer

### **Production Function and Law of Variable Proportions**

**Production function** shows how output depends on inputs.
- Q = f(L, K, ...)

In the **short run**, at least one input is fixed. When we increase only the variable input (say labor), the **law of variable proportions** operates.

```text
Increase variable input (L)
   ↓
TP rises fast initially (better utilization)
   ↓
TP rises slowly (diminishing MP)
   ↓
TP may fall (negative MP)
```

**Key points for exam:**
- MP rises initially due to specialization.
- Later MP diminishes because fixed factor limits output.
- Stage II (MP positive but falling) is the **rational stage**.

Thus, the production function and returns to a factor explain how output behaves when inputs change in the short run.

Question 14

Explain short-run cost curves (AFC, AVC, AC, MC) with a table and curve-relationship points (exam-style).

Accepted Answer

### **Short-Run Cost Curves and Relationships**

| Cost | Formula | Typical shape |
|---|---|---|
| **AFC** | TFC/Q | falls continuously |
| **AVC** | TVC/Q | U-shaped |
| **AC** | TC/Q = AFC + AVC | U-shaped |
| **MC** | ΔTC/ΔQ | U-shaped |

**Key curve relationships (write any five):**
- AFC falls as output increases because fixed cost is spread.
- AVC is U-shaped due to increasing returns first and diminishing returns later.
- AC is U-shaped because it depends on both AFC and AVC.
- MC cuts **AVC** at the minimum point of AVC.
- MC cuts **AC** at the minimum point of AC.

```text
If MC < AC → AC falls
If MC = AC → AC minimum
If MC > AC → AC rises
```

Thus, cost curves help managers understand cost behavior and take pricing/output decisions.

Question 15

Explain returns to scale and long-run average cost (LAC) curve with a table/flowchart (exam-style).

Accepted Answer

### **Returns to Scale and Long-Run Average Cost (LAC)**

**Returns to scale** applies in the long run when all inputs are increased proportionately.

| Type | Meaning | Usual reason |
|---|---|---|
| **Increasing returns** | output rises more than inputs | specialization, economies of scale |
| **Constant returns** | output rises in same proportion | efficient scale |
| **Decreasing returns** | output rises less than inputs | coordination and managerial inefficiency |

**LAC curve (envelope concept):**
- In the long run, firm can choose the best plant size.
- LAC is an **envelope** of short-run AC curves.

```text
Small output → choose small plant
Medium output → choose optimal plant (economies)
Very large output → diseconomies → LAC rises
```

Thus, returns to scale and LAC explain how cost changes when the firm expands in the long run.

Production and Cost Analysis: Production Function, Returns, Cost Concepts and Cost Curves

8 more questions to unlock