58 Guide to Economics

Unit-3

PRODUCER BEHAVIOUR

SOME IMPORTANT DESCRIPTION

l Production Function :
Production refers to the transformation of inputs into output. Inputs are those goods
or services which contribute to the production of an output. Inputs are also known as
factors of production.
The relation between inputs employed and outputs produced is given by the production
function. A production function is a technological relationship b/w output and the factors
or production.
A two factor production function is expressed as :
Q = f(L, K); Where Q = Output
L = Labour
K = Capital
l Short run :
In the theory of production short run refers to the period when at least one factor
of production is kept unchanged. Usually, it is assumed that most of the factor are
fixed during the short run. Thus in short run a firm cannot change some of the
factors, such as costly machines to change its level of output.
A short run production function can be expressed as
Q = f (L, K) ; Where Q = Output
L = Variable input, Labour
K = Fixed input Capital
l Long run :
Long run refers to that period of production when all factors (inputs) are variable.
Long run denotes the planning horizon during which a firm can change all factors to
charge its level of output. Thus the long run production function is expened as :
Q = f(L, K); Where Q = Output
L = Variable input—Labour
K = Variable input—Capital
l Concepts of total product (TP), Average product (AP) and marginal product
(MP)
Ans. In the production process when a variable input is employed continuously keeping
all other factors and technology constant, the total output derived for the different levels
of the variable input is called the total product. Thus the total product (TP) is the total
(58)
Unit-3 : Producer Behaviour 59

volume of the commodity produced in a specified period of time.

The average product (AP) is defined as the output (Q) per unit of the variable
input. Thus average product :
Total product (Q)
(AP) = ————————————————————
Number of units of the variable input
The marginal product (MP) of a variable factor refers to the change in the total
product resulting from one unit additional change in the level of employment of the
variable factor. If we assume labour(L) as the only variable factor then the marginal
product of labour (MPL) is defined by
∆Q
MPL = where ∆Q = change in output
∆L
and ∆L = change in labour.
l The law of variable proportions :
Ans. In the production process when the
only variable factor is introduced TP,
l
continuously keeping all other factors and AP,
technology unchanged, then the output or MP C
A
the total product (TP) first increases at an
increasing rate, then at a decreasing rate,
TP
reaches a maximum and finally falls. This
is known as the law of variable proportion,
which happens due to changing proportion
between variable factors.
The law of variable proportion is related
to the short period. Labour
O L1 L2 L3
Various stages of the law of variable
proportion can be explained with the help
of the above diagram :
In we have drawn Total Product Curve
on the basis of the Law of Diminishing Marginal Productivity. We measure Productivity
of Labour along the vertical axis and units of labour employed by the firm along the
horizontal axis. When labour employed is zero TP is also zero. Hence TP curve starts
from the origin that is (0, 0) point. Upto the employment of OM of labour Total
Product (TP) rises at an increasing rate. It is indicated by the point A on TP curve.
OA zone of TP shows increasing productivity. From 'A' TP rises at a decreasing rate,
but still the Total Product is becoming higher and higher. This process goes along AC
part of TP curve. When the firm employs OH2 labour TP is CM2. It is maximum
quantity of TP. At 'C' the growth rate of TP is zero. If the firm employs more labour
TP declines. When employment is OM3, TP is CM2. After point 'C' TP becomes less
than before. Hence the firm does not employ labour beyond OM2.
From the nature of TP curve we can analyse the nature of Average Product and
Marginal Product of the Variable Factor
l Stages of production :
In the production process when the only variable factor is introduced continuously
keeping all other factors and technology unchanged, then the output or the total product
(TP) first increases at an increasing rate, then at a decreasing rate, (TP) reaches a
60 Guide to Economics

maximum and finally falls. This is known as the law of variable proportion, which happens
due to changing proportion between variable factors.
The law of variable proportion is related to the short period. This law has three forms
or stages :
Various stages of the law of variable proportion can be explained with the help of
the following diagram :
In the above figure we have drawn Total Product Curve on the basis of the Law of
Diminishing Marginal Productivity. We measure Productivity of Labour along the vertical
axis and units of labour employed by the firm along the horizontal axis. TP curve starts
from the origin that is (0, 0) point. Upto the employment of OM of labour Total Product
(TP) rises at an increasing rate. It is indicated by the point A on TP curve. OA zone of TP
shows increasing productivity. From 'A' TP rises at a decreasing rate, but still the Total
Product is becoming higher and higher. This process goes along AC part of TP curve.
When the firm employs OM2 labour TP is CM2. It is maximum quantity of TP.
In the following diagram, average and marginal products are drawn. Average product
(AP) keeps on increasing as long as the marginal product (MP) is higher then it. As soon
as MP cuts AP and becomes less then AP (MP<AP), the average product starts falling.
Thus when AP is maximum, AP equals MP (AP = MP), upto this point on TP curve is
known as the first stage of production.

The second stage of production is considered as that level where the marginal
product is positive but less than the average product (MP > 0, & MP < AP) and AP is
falling, i.e. until the total product (TP) reach the maximum.
The third stage is where the TP is falling, AP is positive but MP is negative.
Unit-3 : Producer Behaviour 61

The firm produces at stage II. At this stage production can be increased without
increasing the fixed cEost. Employing more units of the variable factor the firm gets
additional output. At stage III the Marginal Productivity is negative. Hence by
employing more units of the variable factor the firm incurs loss. At stage III the firm
will not produce.
l Returns to Scale :
In the long run expansion of output may be achieved by varying all factors i.e. by
changin the scale of production. The laws of returns to scale refer to the effects of
scale relationships. In the long run, output may be increased by changing all factors
by the same proportion or by different proportions. Traditional theory of production
concentrates on the first case. The term returns to scale refers to the changes in
output as all factors changed by the same proportion.
There may be three types of returns to scale :
(1) Comtant returns to scale (CRS)
(2) Increasing returns to scale (RS)
(3) Decreasing returns to scale (DRS)
If in the production process it is found that the output level changes in the same
proportion in which the inputs are changed, then there is said to be constant returns
to scale. (CRS)
If the output level increases in a greater proportion than the increase in inputs,
then production is said to be subject to increasing returns to scale. (IRS)
If the output level increases at a lower proportion than the increase in inputs, then
there is said to be decreasing returns to scale. (DRS)
l Returns to a variable factor and Returns to scale :
When the only one variable factor of production is continuously employed keeping
the other factors constant, the proportion between the factors is changed and
nesultaully the output changes at different rates. This is refund to as returns to a
variable factor.
On the other hand when all the inputs of production are increased (or decreased)
at a particular proportion the output may change at the same, greater or even lesser
proportions. This is known as returns to scale.
We may point out the differences of these two laws of production as under :
Returns to a variable Returns to scale
factor or Laws of Returns
(1) Only one input is variable (1) All the inputs are variable.
while all other inputs are constant.
(2) This is a short run phenomenon. (2) This is a long run phenomenon.
(3) Usually, the production function (3) The production function is homogeneous.
is non-homogeneous
(4) In laws of returns the out-put (4) The different returns to scale operates
increase at increasing rate due to due to the advantages of internal economies
proper utilisation of the fixed factors in the first phase and different diseconomies
in the first stage. After the optimum of scale in later phases.
proportion between fixed and
variable factors is achieved, the
output rises at decreasing rate.
62 Guide to Economics

l Economics of scale :
When the production increases due to the expansion of the firm, producers reap
some benefits. These benefits reduce the average cost of production. These are called
economies of scale. Economies of scale are of two types : Internal and External.
l Internal Economies :
The economies enoyed by a particular firm as a result of expansion of its own
output are called internal economies of scale. Internal economies can be of different
types. These are discussed below.
(i) Technoligical economies : In modern industries, the technology of production
is often such that, when production increases, the average cost of production
decreases. If the firm decides to expand its output, the firm does not necessarily have
to employ all the factors in same proportion. As a result. Cost per unit of output will
fall. This is known as technological economies.
(ii) Managerial economies : Expansion of the scale of production also leads to
economising on managerial efforts. When the level of production starts increasing
from a very low leel, the manager of the firm does not necessarily have to devote a
greater effort in the supervision of the firm. Therefore, the average cost of production
will fall because, while output is increasing, one part of the cost of production (viz.,
cost of management) is remaining the same. These economies are called managerial
economies.
(iii) Pecuniary economies : Usually a large firm enjoys some advantages in
business matters over a small firm. For instance, when raw materials are purchased
in large quantities, the sellers of these materials offer attractive discounts. Similar
discounts are available on transport costs when large quantities of output are
despatched to the market. A large company can also borrow money for investment at
low rates of interest from commercial banks because they can provide the necessary
securities or collaterals. This also is an important reason why the average cost of
production of a firm falls when its production expands. Economies of this type are
called pecuniary economies.
(iv) Economies of diversification : A large firm can produce a variety of products.
When there is a depression in the market for some of the products, it can concentrate
on selling the other products. Similarly, a large firm usually procures its raw
materials from a variety of sources. If there is a problem with one of the sources, it
can fall back on the other sources. In this way, a large firm can reduce its risk by
diversifying its production and purchases. This effectively reduces the risk give some
cost benefits. A small firm does not enjoy this advantage. We can, therefore, say that
a firm can get this type of benefits more as its scale of production increases.
Economies like this are called diversification economies.)
(v) Economies of research and development : A large firm)earns a greater
amount of profit than a small one. Therefore, it can devote a large amount of funds
to research and development activities. These activities help in innovations and lower
the average cost of the firm by finding newer and better ways of producing and
marketing the products. Such economies are called the economies of research and
development.
(vi) Economies of welfare : Since a large firm enjoys large profits, it can afford
to spend a good deal of money on welfare of the workers (for instance, on their
medical benefits and entertainment) as well as on their technical training. Such
Unit-3 : Producer Behaviour 63

expenditure reduces average cost of production, not only by raising the efficiency of
the workers who are already employed in the firm, but also by attracting better types
workers from outside. This, again, implies that a firm's average cost decreases as it
becomes larger in size. Economies of this type are called economies of welfare.
l External Economies :
When the output of a firm increases, the other firms in the industry get some
advantages. These are called external economies of scale since they come from the
expansion of output of another firm. Thus the sources of external economies lie
outside the firm. External economies can be of various types :
(i) Economies of centralisation : When an industry develops in a certain region,
all firms in the industry get some external advantages. For instance, infrastructural
facilities required for this particular type of production are built up in the region.
Transport and communication networks are easly available. Labour and other inputs
of the particular type required in this line of production also become more easily
available because these inputs get attracted to this region. All this lowers the cost of
production. To a particular firm, therefore, these economies are external. These are
called economies of centralisation.
(ii) Economies of information : Again, when the total output of an industry
increases all firms enjoy economies of information. It becomes easier to disseminate
information about cost and market conditions. This can save some research costs of
the firms and reduce the average cost of production. This way of spreading business
information is not feasible when the size of the industry is small.
(iii) Economies of specialisation : Another type of external economy arises when
an increase in the size of the industry allows the different firms within the industry
to specialise in different directions. For instance, if the textile industry consists of a
large number of firms, one firm may specialise in spining, another in weaving and so
on. Such specialisation allows each firm to reduce average cost of production by
increasing efficiency.
l Cost function :
The cost function of a firm shows the interdependence between the total cost of
production (c) and the level of output (Q) during any time period. A cost function is
expressed as :
C= f(Q); Where Q = Output
C = Total cost of production
l Fixed and variable cost : In the traditional theory of cost, the short run cost
function is decomposed into total fixed cost (TFC) and total variable cost (TVC)
Fixed cost refers to the costs of the fixed factors in the short run. Fixed cost does
not change with the changes in output. Salary of the permanent workers, fixed rent
etc. are fixed costs of production.
On the other hand, the costs which varies with output level are variable costs. In
other words, the costs of the variable factors of production are called variable costs.
Cost of raw materials, wages paid to casual workers are examples of variable costs.
The fixed cost occurs only in the short run, but variable costs appear both in short
run and in long run.
Fixed cost remains positive and constant, even when output is zero. But variable
costs become zero for zero output level.
We may explain the shortrun costs in the following
64 Guide to Economics

Cost
TC

TVC

A TFC

O
Production

Adding together the TFC and TVC we get the total cost (TC) curve.
TFC is paralal to the horizontal axis as it remains a constant throughout.
Both TVC and TC rises at a decreasing rate upto a certain point due to economics of
scale and then it rises at an increasing rate due to diseconomics of scale.
The shapes of TC, TVC and TFC are shown in the diagram above page :
In the above diagram, the slopes of TC and TVC are same at every production level.
The constant gap between TC and TVC decribes TFC.
l Average cost : Average cost is the cost per unit of output.
Total cost (TC)
Thus, Average cost (AC) =
Output
In the short run, TC = TVC + TFC
TC TVC + TFC
⇒ AC = =
Q Q
TC TVC TFC
⇒ AC = = +
Q Q Q
⇒ AC =AVC+AFC
Thus the average cost is the sum total of average variasle cost (AVC) and average
fixed cost (AFC) in the short run.
l Shape of the average cost (AC) Curve :
Average cost is the cost per unit of output. Thus,
the shortrun average cost (SAC) of a firm is defined
C
TC AC
as— AC = , Where TC = Total cost
Q
Q = Output.
Now, following the law of variable proportions
which is applied in the short run production process,
the output first increases, reaches a maximum and
then diminishes. As a result, the average cost of
production first decreases, reaches a minium and then O
rises. Thus the short run average cost curve becomes Q
‘U’ shaped.
Unit-3 : Producer Behaviour 65

l Marginal Cost (MC) :

Marginal cost refers to the change in total cost resulting from one unit additional
change in output. Thus marginal cost is the incremental cost of production and expressed
∆C
as MC = ; where MC = Marginal Cost dc = Charge in Total cost dq = Charge in
∆Q
Quantity produced.
Thus by definition, marginal cost (MC) is the slope of the total cost (TC) curve. If we
draw the tangents on the total cost curve, we find that the slopes are first diminishing
and after a certain level of output the slopes rises. Therefor we get that MC curve will
first decline as the output rises and after reaching a minimum level, it would be rising.
Thus the MC curve will be a ‘U’ shaped curve. This is shown in the following diagram.

MC

l Relation between average cost (AC and marginal cost (MC) :

By definition Marginal cost (MC) is the change in Total Cost due to one unit
dTC
change in output i.e., MC = .
dQ
dTC = change in Total Cost. dQ = change in output.
Average cost is the cost per unit of output.
TC
Thus, AC = or, TC = AC.Q. ; where TC = Total cost,
Q
Q = Output, AC = Average cost.
Now differentiating both sides. w.r.f. Q we get—
dTC dQ dAC dAC
= AC. + Q. , Or, MC = AC + Q.
dQ dQ dQ dQ

d(AC)
Eventually in the above expression indicates the Slope of Average Cost (AC)
dQ
Curve, Now, as we know that the short run AC is U-shaped, we observe the following
relationship between AC and MC :—
66 Guide to Economics

(a) when AC is falling

dAC
<O
dQ
⇒ AC > MC

(b) when AC is at minimum, dAC = O

dQ
⇒ AC = MC

dAC
(c) when AC is rising >O
dQ
⇒ AC < MC
This relationship has been shown in the following diagram.
In the figure the average cost (AC) is falling upto the output level OQ2, and in this
region AC curve lies above the marginal cost (MC) curve, i.e., AC > MC.

AC MC
AC
MC

O Q1 Q2 Q3 Q

At OQ2 level of output AC is minimum, where MC cuts it. Thus AC equals MC. If
the output rises beyond OQ2 level, MC becomes greater than AC, so MC curve lies
above the AC curve.
l Opportunity Cost :
The concept of opportunity cost has been propounded by Austrian School of
Economists. According to this concept the inputs are limited in supply and they have
alternative uses.
The opportunity cost refers to the next best alternative income of an input. For
example, a plot of land may produce 100 KG of wheat or 60 KG of cotton. If wheat
is produced, cotton cannot be grown and viceversa. Now the opportunity cost of
production of 100 KG of wheat is 60 KG of cotton and the opportunity cost of
production of 60 KG of cotton is 100 KG of wheat. The opportunity cost is calculated
in terms of the commodity which is foregone or whose thus production is stopped to
produce another commodity.
l Implicit and explicit cost :
Money Cost is total monetary expenditure incurred by the firm for production. It
is separated into two categories—(i) Explicit Money Cost; (ii) Implicit Money Cost.
(i) Explicit Money Cost : The firm directly pays wages, interest, fuel charges etc.
Unit-3 : Producer Behaviour 67

These are explicit money costs. Explicit money cost is direct contractual payment
made by the firm.
(ii) Implicit Money Cost : There are some inputs which are not directly purchased
or the firm does not make any contract with the owners of those inputs e.g., no
contract is made with land owner when the firm uses its own land. But usual rent
is to be included in the calculation of cost of production. Imputed values of own
inputs are implicit costs.
l Long run Total costs :
Generally the Total Variable Cost (TVC) curve starts from the origin because TVC
= 0 when the level of output (Q) is 0. However, in the longrun, there is no fixed factor
and Total Cost (TC) of production of any firm is equal to its TVC. So, in the longrun,
TC will start from the origin. This has been shown in below.

l Long run Average Cost :

The long run average cost curve is the locus of the minimum costs for
producing any level of output when all factors of production are variable. Thus if
is the outer envelope of the short run average cost (SAC) curves. Now as in the
initial stage of production the increasing returns to scale operates in the
production process, the “SAC” curves gradually shift in the downward direction,
as the firm enjoy economies of scale. At next stage when the disccanamics of scale
appears, the SAC curves shift up wardly. Thus as an outer envelope of the
shortrun average cost curves, we obtain a flater “U” shaped long run average cost
(LAC) curve. This can be shown in the diagram below.
l Revenue of a firm :
Revenue refers to the income of a firm through the sale of goods at different
Average
Cost
SAC7
SAC1

SAC2
SAC6
SAC3
SAC5
SAC4

O Q
(Output)
68 Guide to Economics

prices. The revevue concepts are concerned with total revenue (TR), average
revenue (AR) and marginal revenue (MR).
l TR, AR and MR :
The total revenue (TR) of a firm is the earning of the ferm by selling is output.
Thus total revenue (TR) = Price (P) × output sold (Q)
The average revenue (AR) is the total revenue per unit of sale. Thus
TR P ×Q
AR = = = P
Q Q
Marginal revenue refers to the change in total revenue per unit charge in sale
∆TR
of the output Thus, MR = = Slope of TR
∆Q
If the price (P) is fixed then the total revenue
TR (TR) curve will be an upward sloping straight
line through the origin. The slope of the TR
TR dTR
curve is expressed as dQ (i.e., change in TR due
to a small change in quantity sold). It also signifies
the Marginal Revenue (MR) of the firm. When P is
fixed then P = MR. Therefore, we get such given
positive slope of the TR curve.
When the price is fixed, i.e., the demand curve
is perfectly elastic (e P → ∞ ) then the average
Q revenue (AR) becomes equal to the marginal revenue
O
(MR). This is shown below.
The relation between marginal revenue (MR), Average revenue (AR) or price (AR = P)
and the price elasticity of demand (e) can be explained by the following equation :

P, AR, MR

P AR = MR
e →∞

Q
O

Where, MR = AR 1 −
FG 1 IJ
H e K
MR = Marginal Revenue.
AR = Average Revenue = Price.
e = Elasticity of demand.
When price is changing we may have a downward sloping linear average revenue
(AR) curve ie. the demand curve. As the AR falls from left to right marginal revenue
Unit-3 : Producer Behaviour 69

(MR) also falls but always remains smaller then AR (i.e., MR<AR). At the mid point
of AR, where price elasticity is unity (ep=i) there the MR becomes zero and beyond this
MR is negative.
AR, MR

e=1

O Q

MR
The relation between AR and MR is explained in the above diagram.
F 1I
We know that MR = AR GG1 − e JJ
H p K
where MR = Marginal Revenue, AR = Average Revenue and eP = Price elasticity of
demand.
Now, if MR = 2 and e = 2 then it follows that,
FG1 − 1 IJ
2 = AR
H 2K Or, AR = 4

Thus the value of AR is 4 units.

The significance of Revenue in the theory of firm are stated below :
(i) Revenue of a firm is significant to asses change in price.
(ii) It is useful to determine maximum profit under marginal principle i.e. MR =
MC.
There are two conditions for profit maximisation.
(i) The First-order condition or the necessary condition requires that at equilibrium
the marginal revenue (MR) must equal the marginal cost (MC), i.e., MR = MC.
(ii) The second order or the sufficient condition requires that at equilibrium slope
of MC>slope of MR.
l Relation between TR, AR, MR and ep when price is not fixed under
imperfect market :
The law of diminishing marginal utility was explained by Prof. Marshall. The law
states that as an individual’s consumption of a commodity increases, the marginal utility
derived from successive units of that commodity decreases.
This law has been obtained from experience where it is found that as a consumer
consumes more and more units of a commodity, the intensity of desire for that
commodity gradually decreases. This is why the consumer will be willing to pay less
70 Guide to Economics

and less for additional units. This means that marginal ulitity diminishes to the
consumer.
According to cardinal utility theory of Marshall utility can be measured in terms of
money. It is measured by money price which the consumer is ready to pay for one
additional unit of a commodity.

MR

l Equilibrium of a firm—Profit maximisation :

The objective of a firm is to earn maximum profit. The firm produces commodity
and incurs cost of production. Then the firm sells the output in the market and gets
revenue. The difference between Revenue and cost is profit.
Thus, profit (Λ) = TR = TC; Where TR = Total revenue of the firm
TC = Total cost incurred
Under imperfect market conditions, profit is maximum where the slope of TR (i.e.
MR) is equal to the slope of TC (i.e. MC). This is explained in the following diagram.
Unit-3 : Producer Behaviour 71

Cost, Revenue TC

TR
π

Output
O Q1 Q2 Q3

Fig. 4.21 Imperfect Market.

In the above diagram Λ (profit) is maximum when output is Q2 At Q1 and Q2 level

of output, profit (Λ) is zero. Thus the condition for profit maximisation is :

∆TR
Or, MR − MC = 0 (By definition, = MR and
∆Q
∆TR
Or, MR = MC = MC)
∆Q
Profit maximisation under perfect market :
In a perfectly competitive market, the marginal revenue (MR) equals the average
revenue (AR) or Price (P), since the price remains constant.
Thus we have AR = MR = P ( P = foxed price)
Hence at the profit maximising output level
MR = MC
Or, P = MC ( Q P = MR)
i.e. Price = Margina cost.
Note : For profit maximisation MR = MC is the necessary condition. But this
is not sufficient condition for profit maximisation. When output is small profit is
zero. When output is very large profit is again zero (as shown in the figure points
Q1 and Q3). In between Q1 and Q3, profit function reaches the maximum height at
output level Q2. From this agreement we get the second order condition for profit
maximisation. When p reaches the maximum level the slope of MR becomes less
than the slope of MC.

dMR dMC
This is written as <
dQ dQ
72 Guide to Economics

This condition is called the sufficient condition for maximisation of profit of the
firm.
l Based on the above discussions, you will be able to solve the following multiple
choice questions (MCQ).
1. Which of the following is used in production as a gift of nature?
(a) Labour (b) Capital
(c) Land (d) Organisation
Ans. (a) Labour
2. Which of the following is called produced means of production?
(a) Labour (b) Capital
(c) Land (d) Organisation
Ans. (b) Capital
3. Which of the following is not the characteristic of land as a factor of production
(a) Gift of nature (b) Not transferable (Other than ownership)
(c) Different types are available (d) Unlimited supply
Ans. (d) Unlimited supply
4. Which of the following is not a characteristic of capital as a factor of production?
(a) Product of past labour (b) Source of future income
(c) Result of saving (d) Gift of nature
Ans. (d) Gift of nature
5. Transformation process of the factors of production into the final product is
the
(a) Technique of production (b) Production function
(c) Returns to factor (d) Expansion path
Ans. (b) Production function
6. The physical or technological relation that exists between amount of output of
any commodity and the amount of inputs which are used to produce the commodity
is called
(a) Production function (ii) Returns to scale
(c) Law of variable proportion (d) Output function
Ans. (a) Production function
7. The production function in which the inputs are used in fixed proportion ie.
one input cannot be used in substitute of the other input is called
(a) Fixed coefficient production function
(b) Variable coefficient production function
(c) Cobb-Dauglus production function
(d) Law of variable proportion
Ans. (a) Fixed coefficient production function
8. When the total product or output is divided lay the used amount of an input,
it is called the
(a) Average product (b) Average revenue
(c) Marginal revenue (d) Marginal product
Ans. (a) Average product
9. Change in total output due to change in the employment of one unit of an
input keeping other things ramain constant is called.
(a) Marginal product (b) Average product
(c) Total product (d) Total revenue
Ans. (a) Marginal product
Unit-3 : Producer Behaviour 73

10. When average product curve is downward sloping then marginal pred curve is
(a) Above the average product curve (b) Below the average product curve
(c) Equal to average product curve (d) Parallel to horizontal axis
Ans. (b) Below the average product curve
11. At the highest point of average product curve, the marginal producer curve
(a) Intersects the average product curve
(b) Is above the average product curve
(c) Is below the average product curve
(d) Is parallel to average product curve
Ans. (a) Intersects the average product curve
12. In a production process, other inputs remaining constant if one imput is increased
continuously then the marginal product of the variable put is decreased continuously
after a certain level. This is called
(a) Law of diminishing returns (b) Law of increasing returns
(c) Law of constant returns (d) Law of returns to scale
Ans. (a) Law of diminishing returns
13. When a single variable input is employed continuously keeping other factors
constant, how may stages of production occurs?
(a) one (b) Two
(c) Three (d) Four
Ans. (c) Three
14. For a single variable input production, the produces would like to produce at the
(a) First stage (b) Second stage
(c) Third slage (d) Fourth stage
Ans. (a) First stage
15. In a production process if a firm vary all the factors of production inputs
which the firm uses for production in the same proportion and in the w direction
then it is called
(a) Returns to scale (b) Returns to factor
(c) Returns to fixed factor (d) Returns to variable factor
Ans. (a) Returns to scale
16. If the rate of change in output is equal to the rate of change in which all the
factors of production are changed then it is called
(a) Constant returns to scale (b) Increasing returns to scale
(c) Decreasing returns to scale (d) Decreasing returns to factor
Ans. (a) Constant returns to scale
17. If the rate of change in output less than the rate of change in which all the
factors of production are changed then it is called
(a) Decreasing returns to scale (b) Increasing returns to scale
(c) Constant returns to scale (d) Returns to variable factor
Ans. (a) Decreasing returns to scale
18. Which of ete following is an example of External Economies?
(a) A lange firm enjoys discount
(b) A fall in average cost due managerial efforts
(c) A fall in average cost due to technological upgradation
(d) Infrastructural facilities buit in the region.
Ans. (d) Infrastructural facilities buit in the region.
74 Guide to Economics

19. When a firm gets cost benefits due to specialisation, it is called

(a) Division of labour (b) Technological Economies
(c) External Economies (d) Diversification of output.
Ans. (b) Technological Economies
20. Cost of production expressed in terms of money is called
(a) Economic cost (b) Real cost of production
(c) Opportunity cost (d) Accounting cost
Ans. (a) Economic cost
21. Money expenses incurred for hireing different factors of production are called
(a) Accounting cost (b) Real cost
(c) Implicit cost (d) Social cost
Ans. (a) Accounting cost
22. Pain, mental agony and sacrifice incunt by the owner of the factors of
production for supplying the factors of production to produce output is called
(a) Real cost of production (b) Money cost of production
(c) Opportunity cost of production (d) Implicit cost of production
Ans. (a) Real cost of production
23. Which one of the following is not the defects of real cost of production?
(a) Measurable
(b) Cannot explain the nature of land rents
(c) Defective real cost of capital accounting
(d) Cannot explain the relation among wage increase and the development of science
and technology
Ans. (d) Cannot explain the relation among wage increase and the development of
science and technology
24. The amount of expllelt and implicit cost bear by the firm for the duction of
commodity whose burden cannot be shifted to others is called
(a) Social cost (b) Private cost
(c) Opportunity cost (d) Short run cost
Ans. (b) Private cost
25. In production planning of the factors of production cannot change producer,
a period of time in which all the even though necessary is called
(a) Long run (b) Private cost
(c) Very long run (d) Infinite time period
Ans. (b) Private cost
26. In production planning of the producer, a period of time in which all the
factors of production can change if necessary is called
(a) Short run (b) Long run
(c) Very short run (iv) Finite time period
Ans. (b) Long run
27. The costs which are not changed along with the change in the amount of
production i.e. the cost which are not dependent on the amount of production is
the
(a) Fixed cost (b) Variable cost
(c) Implicit cost (d) Opportunity cost
Ans. (a) Fixed cost
28. The costs which are changed along with the change in the amount of produc-
tion Le. the costs which are dependent on the amount of production is called
(a) Variable cost (b) Fixed cost
(c) Implicit cost (d) Reat cost
Unit-3 : Producer Behaviour 75

Ans. (a) Variable cost

29 Total cost in the short run can be divided into two parts
(a) Fixed cost and variable cost
(b) Money cost and real cost
(c) Money cost and accounting cost
(d) Private cost and social cost be divided into two parts
Ans. (a) Fixed cost and variable cost
30 Shape of the total fixed cost curve is
(a) Straight line parallel to amount of production axis (horizontal axis)
(b) Upward rising straight line
(c) Downward sloping straight line
(d) Convex to the origin
Ans. (a) Straight line parallel to amount of production axis (horizontal axis)
31. Total fixed cost of any amount of production divided by that amount of
production is called
(a) Average fixed cost (b) Average variable cost
(c) Average total cost (d) Marginal cost
Ans. (a) Average fixed cost
32. Shape of the average fixed cost curve is
(a) U-shaped (b) V-shaped
(c) Rectangular hyperbola (d) Downward sloping straight line
Ans. (c) Rectangular hyperbola
33. Total variable cost of any amount of production divided by that amount of
production is called
(a) Average variable cost (b) Average fixed cost
(c) Average total cost (d) Average cost
(1) Average variable cost
Ans. (a) Average variable cost
34. Shape of the average variable cost curve is
(a) U-shaped (b) Rectangular hyperbola
(c) Downward sloping straight line (d) Concave to the origin
Ans. (a) U-shaped
35. At any level of output, the ratio of total cost and the output level is called
(a) Average total cost (b) Average variable cost
(c) Average fixed cost (d) Marginal cost
Ans. (a) Average total cost
36. The average cost (AC) curve lies———the average variable cost curve (AVC)
(a) Betow (b) Above
(c) Parallel to (d) Beside
Ans. (b) Above
37. The shape of average cost (AC) curve of a firm is :
(a) Downward sloping
(b) Upward rising
(c) Initially downward sloping then upward rising
(d) Horizental straight line
Ans. (c) Initially downward sloping then upward rising
38. Which one of the following is an example of fixed cost of a firm?
(a) Cost on account of wages (b) Electtricity and fuel cost
(c) Payment for insurence premium (d) Expenditure on purehose of rawmaterials
Ans. (c) Payment for insurence premium
76 Guide to Economics

39. The vertical distance between the total cost (TC) and total variable cost (TVC)
curve is
(a) Total fixed cost (b) Marginal cost
(c) Average cost (d) Real cost
Ans. (a) Total fixed cost
40. When the average cost declines, which of the following is true?
(a) AC < MC (b) AC > MC
(c) AC = MC (d) AC coinsides with MC
Ans. (b) AC > MC
41. In the short run, change is total variable cost is the
(a) Average variable cost (b) Marginal cost
(c) Average fixed cost (d) Average cost
Ans. (b) Marginal cost
42. Marginal cost arise in
(a) Short run (b) Long run
(c) Both short run and long run (d) Doesn’t arise
Ans. (c) Both short run and long run
43. In the long run there is no
(a) Variable cost (b) Fixed cost
(c) Opportunity cost (d) Marginal cost
Ans. (b) Fixed cost
44. According to the modern economists, the long run average cost (LAC) curve
is—
(a) Downward sloping (b) Downward sloping and than horizontal
(c) Horizontal straight line (d) ‘U’ shaped
Ans. (b) Downward sloping and than horizontal
45. At the minimum of the average cost—
(a) AC = AVC (b) AC = AFC
(c) AC = MC (d) AC > MC
Ans. (c) AC = MC
46. Long run average cost curve is the envelope of the
(a) Short run average cost curves
(b) Short run average fixed cost curves
(c) Short run average variable cost curves
(d) Short run marginal cost curves
Ans. (a) Short run average cost curves
47. Under constant returns to scale long run average cost curve is
(a)Straight line parallel to horizontal axis
(b) U-shaped
(c) Downward sloping straight line
(d) Upward rising straight line
Ans. (a)Straight line parallel to horizontal axis
48. Under variable returns to scale long run average cost curve is
(a) U-shaped
(b) Parallel to horizontal axis
(c) Straight line parallel to vertical axis
(d) Upward rising straight line
Ans. (a) U-shaped
Unit-3 : Producer Behaviour 77

49. Which one of the following is not the relation between the short run average
cost curve and long run average cost curve?
(a) Long run average cost curve can be separated from the short run aven cost curve
(b) Long run average cost cannot be greater than the short run average cost for any
amount of production
(c) Short run average cost curve and long run average cost curve both are U-shaped
but the long run average cost curve is flatter than the short run average cost curve
(d) Minimum point of the long run average cost curve is tangent only at the minimum
point of short run average cost curve
Ans. (a) Long run average cost curve can be separated from the short run aven cost
curve
50. In modern approach short run total cost is the sum of total fixed cost, total
variable cost and
(a) Normal profit (b) Money cost
(c) Opportunity cost (d) Social cost
Ans. (a) Normal profit
51. Imputed cost of the firm for inputs owned by the organiser is known as—
(a) Money cost (b) Explicit cost
(c) Real cost (d) Implicit cost
Ans. (d) Implicit cost
52. The average cost is minimum when
(a) Average cost = Merginal cost (b) Average cost > Marginal cost
(c) Average cost < Marginal cost (d) Marginal cost is diminishing
Ans. (a) Average cost = Merginal cost
53. Total variable cost (TVC) curve—
(a) Starts from the origin, first upward concare then convex
(b) Starts from the origin, first upward carves then concave.
(c) Starts from the origin, downward convex
(d) Straight line parallel to the horizontal axis
Ans. (a) Starts from the origin, first upward concare then convex
54. The amount of money received by a firm by selling its product is known as—
(a) Total cost (b) Average revenue
(c) Total revenue (d) Marginal revenue
Ans. (c) Total revenue
55. The amount of money received by the firm per unit of selling its product is
the
(a) Average revenue (b) Total revenue
(c) Marginal revenue (d) Total cost
Ans. (a) Average revenue
56. If the price is fixed, the TR curve will be
(a) Downward sloping
(b) Horizontal straight line
(c) Vertical straight line
(d) Upward sloping straight line passing through the origin
Ans. (d) Upward sloping straight line passing through the origin
57. The additional revenue curved by a firm by selling one additional unit of its
product is known as
(a) Total revenue (b) Marginal revenue
(c) Average revenue (d) Marginal cost
Ans. (b) Marginal revenue
78 Guide to Economics

58. If the price is fixed then

(a) AR > MR (b) MR > AR
(c) AR = MR (d) AR = TR
Ans. (c) AR = MR
59. For a downward sloping demand curve
(a) AR > MR (b) MR > AR
(c) AR = MR (d) P = MR
Ans. (a) AR > MR
60. When price is fixed, the MR curve is
(a) Downward sloping
(b) Upward rising
(c) Straight line parallel to the horizontal axis
(d) Vertical straight line
Ans. (c) Straight line parallel to the horizontal axis

61. If AR = 5, ep = 1 2 then MR is
(a) -5 (b) 5
(c) 0 (d) 76
Ans. (a) -5
62. If the price is fixed at Rs 10, then the average revenue is—
(a) Rs 100 (b) Rs 10
(c) Rs 5 (d) 20
Ans. (b) Rs 10
63. Which of the following shows the relation between AR, MR and ep?

 1  1
(a) AR = MR 1 −  (b) MR = AR 1 + 
 ep  e 
 

 1
(c) MR = AR (1 - ep) (d) MR = AR 1 − 
 ep 


 1
Ans. (d) MR = AR 1 − 
 ep 

64. The total revenue is maximum when
(a) ep = 1 (b) ep = 0
(c) ep < 1 (d) ep → α
Ans. (a) ep = 1