Demand and Supply Analysis free essay sample

Fixed cost involves all the expenditure done on fixed factors of production. However, the fixed costs remain constant i. e. they do not vary with the level of output. For instance, interest, insurance premium, rent and wages of permanent employees are categorized as fixed costs. †¢Ã‚  Variable cost –  Variable cost can be defined as the cost that does remain constant i. e. it varies with the level of output. For example, salaries of employees appointed on day to day basis and expenditure made on fuel, power and raw material. Opportunity cost –  It is quite true that the resources are limited; therefore the production of one commodity can only be made possible at the cost of other. The good that is given up is the opportunity cost of the commodity manufactured. †¢ Accounting cost – The accounting cost outlines actual expenditure incurred during the production. †¢ Economic cost –  Aggregate of implicit cost, normal profits and explicit cost. †¢ Explicit cost –  Explicit cost embraces all the money payments done to the suppliers who provide the company with raw materials or many other equipments used in production etc. Implicit cost –  Implicit cost is the aggregate cost of self owned resources. Total cost curves in short run †¢ Total Fixed Cost (TFC) Total Fixed Cost (TFC) is a straight line curve that does not change with the level of output, even in the situation when output is zero unit or one hundred units it remains same all through the course. For example, interest on bonds, insurance premium etc is considered as total fixed cost. Production is an economic activity that makes goods available for consumption. Production at times is also defined as all economic activities minus consumption. It is the process of creating goods or services using various available resources. Production function and Factors of production Production function shows the relationship between the quantity of a good/service produced (output) and the factors or resources (inputs) used. The inputs used for producing these goods and services are called factors of production. Variable factor of Production: A variable factor of production is one whose input level can be varied in the short run. Raw material inputs are a variable factor and unskilled labour is usually thought of as a variable factor. Fixed factor of production: A fixed factor of production is one whose input level cannot be varied in the short run. Capital is usually a fixed factor. Capital refers to resources such as buildings and machinery etc. Thus production generally represented as a function of capital and labour. Q = F (K, L) [pic] Production Possibilities frontier Production possibilities frontier (PPF) curve represents all combinations of goods and services that can be produced using the available goods and resources. The PPF curve is also called Transformation curve. This curve shows the maximum quantity of goods/services that can be produced given the availability of the factors of production. As can be seen from the figure below point X lies beyond the PPF curve and thus the output level of X can’t be reached. Similarly point A lies below the PPF curve which means that the production is below the efficient level. Points B, C and D are different combinations of quantity produced of Good X and Good Y. At all these points the resources or inputs are efficiently utilised [pic] Isoquants Isoquants are those combination of inputs or factors of production which provides an equal or same quantity of output. Isoquant curves are also called Equal product or isoproduct curve. For a production function which denotes isoquant: Q=F(L,K), Q is fixed level of production L = labour and K = Capital are variable The table below shows different combinations of labour and capital required to produce 100 shirts |Capital   |Output   | |Labour |(K) |(Shirts) | |(L) | | | |10 |90 |100 | |20 |60 |100 | |30 |40 |100 | |40 |30 |100 | |50 |20 |100 | Different resources/ inputs are required for production of goods. Same number of outputs can be produced using different input combinations. Isoquant is the combination of all such combination of inputs which produces same output. Thus we have an isoquant curve for every level of output. Since the quantity produced will remain unchanged on an isoquant, the producer is indifferent for different input combinations. In the figure below the producer will be indifferent on points A, B and C since they are on the same isoquant. Also he cannot move to D without increasing both the inputs and would not produce at E due to inefficiency [pic] Similar to Indifference curve as one move to the right of the isoquant, one reaches a higher level of production. Returns to a factor In the short run the output can be increased for a production function by increasing the amount of the variable factor, usually taken to be labour. Thus the responsive change in the output due to a change in the variable input keeping all other things constant is called returns to a factor. Law of variable proportions In short run the output of goods and services is increased by introducing additional variable factor to the production process to a said quantity of fixed factors. Law of variable proportions outlines the various possible output scenarios due to the change in the proportions of fixed and variable factors used for production. If we increase the number of a factor (labour) keeping all other factors fixed (capital), then the proportion between the fixed and variable factors is changed. The law of variable proportions implies that as we keep on adding the variable factor of production the marginal product of that factor keeps on decreasing progressively. Thus after a point every additional unit of factor added will result in a smaller increase in output. The law of variable proportion is also known as law of diminishing marginal returns or law of diminishing returns. The law has several assumptions as below: one input is variable while others are fixed in the short run ll units of the variable input are same and have equal efficiency no change in production technology factors of production like land and labour can be used in different proportions Take for instance, hiring additional employees (a variable resource) to work at a factory will initially increase output but eventually it will become more and more difficult to generate additional output from the fixed resources (due to plant size and equipment limitations) and thus the total output will increase at a decreasing rate and ultimately will start decreasing.