Unit 3 3.

1Production Cost Analysis

3.1.1 Introduction
A business firm is an economic unit. It is also called as a production unit. Production is one of the most important activities of a firm in the circle of economic activity. The main objective of production is to satisfy the demand for different kinds of goods and services of the community.

3.1.2 Meaning of Production

The concept of production can be represented in the following manner. The term Production means transformation of physical Inputs into physical Outputs. The term Inputs refers to all those things or items which are re uired by the firm to produce a particular product. Four factors of production are land, labor, capital and organization. In addition to four factors of production! inputs also include other items like raw materials of all kinds! power! fuel! water! technology! time and services like transport and communications! warehousing! marketing! banking! shipping and Insurance etc. It also includes the ability! talents! capacities! inputs. Production always results in either creation of new utilities or addition of values. It is an activity that increases consumer satiability of goods and services. Production is undertaken by producers and basically it depends on cost of production. Production analysis is always made in physical terms and it shows the relationship between physical inputs and physical outputs. It is to be noted that higher levels of production is an inde" of progress and growth of an organi#ation and that of a society. It leads to higher income! employment and economic
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prosperity. Production of different types of goods and services in different nations indicates the nature of economic inter dependence between different nations. The primary and the ultimate aim of the economic activity is the satisfaction of human wants. In order to satisfy these wants individuals have to put in efforts to produce goods $ services. %ithout production there cannot be satisfaction of wants. &ommonly understood! production refers to creation of something tangible which can be used to satisfy human want. 'owever! matter already e"ists. %e cannot create a matter. %e can only add utilities to the e"isting matter by either changing its form! place or keeping it over time $ create values. (or e"ample) %e can transform a log of wood into a piece of furniture! thereby adding utility. This process of addition of utilities to the e"isting matter by changing its form! place and keeping it over time is referred to as Production in *conomics. %e can therefore add form utility! time utility! place utility or personnel utility. Addition of all such utilities to the e"isting matter is referred to as Production in *conomics. 'owever technologically production is referred to as the process of transforming inputs into output. In order to undertake production we re uire certain factors of production such as land! labour! capital $ organi#ation. These factors are the inputs $ the product that emerges at the end of the process of production is referred to as the output.

3.1.3 Agents of production

The agents of production are broadly classified into four categories! vi#. +and +abour &apital and ,rganisation.

-i.

+and in economics has a much wider connotation than being understood merely as a portion of the surface of the earth. In economics! land refers to all the natural resources found on! above and under the surface of the earth and which essentially free gifts of /ature are.

-ii.

+abour essentially refers to the human factor in the process of production. +abour in economics may be defined as human efforts! mental or manual! undertaken in order to add utilities and create values.

-iii.

&apital is a man0made factor of production. %hen labour works on land! it produces two types of goods! consumers1 goods which directly satisfy human wants and capital goods which satisfy human wants only indirectly. &apital goods are those goods which are used to produce other goods. Thus &apital is often defined as the produced means for further production.

-iv.

,rgani#ation refers to that factor of production which coordinates the various other factors -+and! +abour! and &apital. in a manner so as to minimi#e the cost of production and ma"imi#e the output.

Production, as such has two dimensions -i. -ii. Technical or Physical and -ii. (inancial.

In Technical sense production is concerned with conversion of inputs into output. 'owever it should be noted here that production does not necessarily imply merely a physical conversion of inputs into a physically new unit of output.2 but processes like transportation and storage should also be incorporated in the definition of production for they too are involved in addition of utilities to goods. An input refers to any good or service which enters the process of production and an output is the resulting good which emerges as the conse uence of production process.

There is also the financial dimension to the process of production. In fact! production involves cost. &ertain amount of e"penditure is to be incurred to initiate and continue production.

3.2 Production function

The entire theory of production centre round the concept of production function. A production (unction e"presses the technological or engineering relationship between physical uantity of inputs employed and physical uantity of outputs obtained by a firm. It specifies a flow of output resulting from a flow of inputs during a specified period of time. It may be in the form of a table! a graph or an e uation specifying ma"imum output rate from a given amount of inputs used. 3ince it relates inputs to outputs! it is also called as Input output relation. The production is purely physical in nature and is determined by the uantum of technology! availability of e uipments! labor! and raw materials! and so on employed by a firm. A production function can be represented in the form of a mathematical model or e uation as 4 5 f -+! /! 67.etc. where 4 stands for uantity of output per unit of time and + / 6 etc are the various factor inputs like land! capital labor etc which are used in the production of output. The rate of output 4 is thus! a function of the factor inputs + / 6 etc! employed by the firm per unit of time. In microeconomics and macroeconomics! a production function is a function that specifies the output of a firm! an industry! or an entire economy for all combinations of inputs. . This function is an assumed technological relationship! based on the current state of engineering knowledge2 it does not represent the result of economic choices! but rather is an e"ternally given entity that influences economic decision0making. Almost all economic theories presuppose a production function! either on the firm level or the aggregate level. In this sense! the production function is one of the key concepts of mainstream neoclassical theories. 3ome non0mainstream economists! however! reject the very concept of an aggregate production function. Figure - A
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Figure -B

The technological relationship between inputs and output of a firm is generally referred to as the production function. The production function shows the functional relationship between the physical inputs and the physical output of a firm in the process of production. The production function is the Technical relationship telling the ma"imum amount of output capable of being produced by each and every set of specified inputs. It is defined for a given set of technical knowledge. 8 3amuelson.

According to 3tigler! the production function is the name given to the relationship between the rates of input of productive services and the rate of output of product. It is the economist1s summary of technical knowledge.

In fact the production function shows the ma"imum uantity of output. 4! that can be produced as a function of the uantities of inputs 9:! 9;! 9<...9n. In e uation form the production function can be presented as ) 4 5f-9:! 9;! 9<79n! T. %here) 4) 3tands for the physical uantity of output produced. f) represents the functional relationship. 9:! 9;! 9<79n) indicate the uantities used of factors 9:! 9;! 9<79n
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T -read T bar 2. stands for a given 3tate of Technology2 Technology held constant. Production function! thus e"presses the technological functional relationship between inputs and output. It shows that output is the function of several inputs. =esides! the Production function must be considered with reference to a particular period of time and for a given state of technology. It may be remembered that the Production function shows only the physical relationship between inputs and the output. It is basically an engineering concept2 whereas selecting an optimal input combination is an economic decision which re uires additional information with respect to prices of the factor inputs and the market demand for the output.

3.2.1

!at is Production Function"

Production of goods re uires resources or inputs. These inputs are called factors of

production named as land! labor! capital and organi#ation. A rational producer is always interested that he should get the ma"imum output from the set of resources or inputs available to him. 'e would like to combine these inputs in a technical efficient manner so that he obtains ma"imum desired output of goods. The relationship between the inputs and the resulting output is described as production function. A production function shows the relationship between the amounts of factors used and the amount of output generated per period of time. It can be e"pressed in algebraic form as under) 9 5 f -a:! a; !........! an. This e uation tells us the uantity of the product 9 which can be produced by the given uantities of inputs -lands labor! capital. that are used in the process of production. 'ere it may be noted that production function shows only the ma"imum amount of output which can be produced from given inputs. It is because production function includes only efficient production process. The analysis of production function is generally carried with reference to time period which is called short period and long period. In the short run! production function is e"plained with one variable factor and other factors of productions are held constant. %e have
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called this production function as the +aw of >ariable Proportions or the +aw of ?iminishing returns. In the long run! production function is e"plained by assuming all the factors of production as variable. There are no fi"ed inputs in the long run. 'ere the production function is called the +aw of @eturns according to the scale of production. As it is difficult to handle more than two variables in graph! we therefore! e"plain the +aw of @eturns according to scale of production by assuming only two inputs i.e.! capital and labor and study how output responds to their use. %e first of all e"plain the concept of iso uants and their properties.

3.2.2 Factor inputs are of t#o types.

1. Fi$ed Inputs. (i"ed inputs are those factors the uantity of which remains constant irrespective of the level of output produced by a firm. (or e"ample! land! buildings! machines! tools! e uipments! superior types of labor! top management etc. 2. %aria&le inputs. >ariable inputs are those factors the uantity of which varies with variations in the levels of output produced by a firm (or e"ample! raw materials! power! fuel! water! transport and communication etc. The distinction between the two will hold good only in the short run. In the long run! all factor inputs will become variable in nature. Short run is a period of time in hich only the !ariable factors can be !aried hile fi"ed factors li#e plants, machineries, top management etc ould remain constant. Time available at the disposal of a producer to make changes in the uantum of factor inputs is very much limited in the short run. $ong run is a period of time here in the producer ill ha!e ade%uate time to ma#e any sort of changes in the factor combinations. It is necessary to note that production function is assumed to be a continuous function! i.e. it is assumed that a change in any of the

variable factors produces corresponding changes in the out put. Aenerally speaking! there are two types of production functions. They are as follows2

a. '!ort Period Analysis of Production

The short run is a period of time in which only one input -say labor. is allowed to vary while other inputs land and capital are held fi"ed. In the short run! therefore! production can be increased with one variable factor and other factors remaining constant. In the short run! the law of variable proportion governs the production behavior of a firm. The law of variable proportion shows the direction and rate of change in the output of firm when the amount of only one factor of production is varied while other factor of production are held constant. The law of variable proportion passes mainly through two phases! :. ;. Increasing @eturns and ?iminishing @eturns.

In this case! the producer will keep all fi"ed factors as constant and change only a few variable factor inputs. In the short run! we come across two kinds of production functions. :. 4uantities of all inputs both fi"ed and variable will be kept constant and only one variable input will be varied. (or e"ample! +aw of >ariable Proportions. ;. 4uantities of all factor inputs are kept constant and only two variable factor inputs are varied. (or e"ample! Iso4uants and Iso&ost curves.

&. (ec!nical )fficient Co*&ination

Production function establishes a physical relationship between output and inputs. It describes what is technical feasible when the firm uses each combination of input. The firm can obtain a given level of output by using more labor and less capital or more capital and less
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labor. Production function describes the ma"imum output feasible for a given set of inputs in technical efficient manner.

3.2.3 Production Function ta+es ,uantities of Inputs

It is imperative to note that production function does not take unto account the prices of input or of the output. It simply takes into account the uantities of inputs which are employed to produce certain uantities of output.

3.2.- .ong /un Production #it! %aria&le Inputs

The long run is the lengthy period of time during with all inputs can be varied. There are no fi"ed output in the long run. All factors of production are variable inputs. %e now analy#e production function by allowing two factors say labor and capital to very while all others are held constant. %ith both factors are variable! a firm can produce a given level of output by using more labor and less capital or a greater amount of capital and less labor or moderate amounts of both. A firm continues to substitute one input for another while continuing to produce the same level of output. If two inputs say labor and capital are allowed to vary! the resulting production function can be illustrated in the figure :;-a.. In this figure each curve -called an iso uant. represents a different level of output. The curves which lie higher and to the right represent greater output levels than curves which are lower and to the left. (or e"ample! point ? represents a higher output level of ;BC units than point A or = which shows output level of :BC units. The curve iso uant which represents :BC units of output illustrate that the same level of output -:BC units. can be produced with different combinations of labor and capital. &ombination of labor and capital represented by A! can employ ,+: uantity of labor and ,&: units of capital to produce :BC units of output. The combination of labor and capital represented

by point = will use only ,+; units of labor and ,&: of capital to produce the same level of output. Thus! if a country has surplus labor and less capital! it may use the combination of labor and capital represented by point A. In case the country has abundant capital and less labor! it might produce at point =. The iso uants through points A and = shows all the different combinations of labor and capita that can be used to produce :BC units of output. In this case! the producer will vary the uantities of all factor inputs! both fi"ed as well as variable in the same proportion. (or *"ample! The laws of returns to scale. *ach firm has its own production function which is determined by the state of technology! managerial ability! organi#ational skills etc of a firm. If there are any improvements in them! the old production function is disturbed and a new one takes its place. It may be in the following manner) :. The uantity of inputs may be reduced while the uantity of output may remain same. ;. The uantity of output may increase while the uantity of inputs may remain same. <. The uantity of output may increase and uantity of inputs may decrease.

3.2.0 Uses of Production Function

Though production function may appear as highly abstract and unrealistic! in reality! it is both logical and useful. It is of immense utility to the managers and e"ecutives in the decision making process at the firm level. There are several possible combinations of inputs and decision makers have to choose the most appropriate among them. The following are some of the important uses of production function.

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:. It can be used to calculate or work out the least cost input combination for a given output or the ma"imum output input combination for a given cost. ;. It is useful in working out an optimum! and economic combination of inputs for getting a certain level of output. The utility of employing a unit of variable factor input in the production process can be better judged with the help of production function. Additional employment of a variable factor input is desirable only when the marginal revenue productivity of that variable factor input is greater than or e ual to cost of employing it in an organi#ation. <. Production function also helps in making long run decisions. If returns to scale are increasing! it is wise to employ more factor units and increase production. If returns to scale are diminishing! it is unwise to employ more factor inputs $ increase production. Danagers will be indifferent whether to increase or decrease production! if production is subject to constant returns to scale. Thus! production function helps both in the short run and long run decision making process.

3.3 Production analysis

Production function

The technological physical relationship between inputs and outputs per unit of time! is referred to as production function. The relationship between the inputs to the production process and the resulting output is described by a production function. The production function is the name given to the relationship between rates of input of productive services and the rate of output of the product. It is the economist1s summary of technical knowledge.03tigler. *"planation of the meaning of Production (unction) The theory of production begins with some prior knowledge of the technical andEor engineering information. (or instance! if a firm has a given uantity of labour! land and machinery! the level of production will be determined by the technical and engineering conditions and cannot be
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predicted by the economist. The level of production depends on technical conditions. If there is improvement in the techni ue of production! increased output can be obtained even with the same -fi"ed. uantity of factors. 'owever! at a given point of time! there is only one ma"imum level of output that can be obtained with a given combination of factors of production. This technical law which e"presses the relationship between factor inputs and output is termed as production function. Fi$ed Inputs

A fi"ed input is defined as one whose uantity cannot be changed instantaneously in response to changes in market conditions re uiring an immediate change in output. e.g.! =uildings! major capital e uipments and managerial personnel. >ariable Inputs A variable input is one whose uantity can be changed readily when market condition suggests that an immediate change in output is beneficial to the producer. e.g. raw materials and labour services. 3hort @un The short run is that period of time in which uantity of one or more inputs remains fi"ed irrespective of the volume of output. Therefore! if output is to be increased or decreased in the short run! change e"clusively in the uantity of variable inputs is to be made. +ong @un +ong run refers to that period of time in which all inputs are variable. Thus! the producer does not feel constrained in any way while changing the output. In the long run it is possible for the producer to make output changes in the most advantageous way. Production process or method of production is a combination of factor inputs for producing one unit of output

3.3.1 Production Function #it! 1ne %aria&le Input Case

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a. (2) .A

1F %A/IAB.) P/1P1/(I13'

This law is one of the most fundamental laws of production. It gives us one of the key insights to the working out of the most ideal combination of factor inputs. All factor inputs are not available in plenty. 'ence! in order to e"pand the output! scarce factors must be kept constant and variable factors are to increased in greater uantities. Additional units of a variable factor on the fi"ed factors will certainly mean a variation in output. The law of variable proportions or the law of non0proportional output will e"plain how variation in one factor input give place for variations in outputs. The law can be stated as the following. &s the %uantity of different units of only one factor input is increased to a gi!en %uantity of fi"ed factors, beyond a particular point, the marginal, a!erage and total output e!entually decline The law of variable proportions is the new name for the famous 4.a# of 5i*inis!ing /eturns6 of classical economists. This law is stated by various economists in the following manner According to Prof. Benham, &s the proportion of one factor in a combination of factors is increased, after a point, first the marginal and then the a!erage product of that factor ill diminish. The same idea has been e"pressed by Prof.Darshall in the following words. An increase in the uantity of a variable factor added to fi"ed factors! at the end results in a less than proportionate increase in the amount of product! given technical conditions.

&. A''UMP(I13' 1F (2) .A ,nly one variable factor unit is to be varied while all other factors should be kept constant.
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?ifferent units of a variable factor are homogeneous. Techni ues of production remain constant. The law will hold good only for a short and a given period. There are possibilities for varying the proportion of factor inputs.

Illustration
A hypothetical production schedule is worked out to e"plain the operation of the law. (i"ed factors 5 : Acre of land F @s BCCC0CC capital. >ariable factor 5 labor.
Units of Variable inputs (Labor) TP in units 0 AP in units MP in units

C : ; < G B I K J H :C

C :C :; :< :< :; :: :C H J K

C :C :G :B :< J I G ; C 0;

:C ;G <H B; IC II KC K; K; KC

(otal Product or 1utput) -TP. It is the output derived from all factors units! both fi"ed $ variable employed by the producer. It is also a sum of marginal output. A7erage Product or 1utput) -AP.. It can be obtained by dividing total output by the number of
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variable factors employed. Marginal Product or 1utput) -DP. It is the output derived from the employment of an additional unit of variable factor unit (rends in output (rom the table! one can observe the following tendencies in the TP! AP! $ DP. :. Total output goes on increasing as long as DP is positive. It is the highest when DP is #ero and TP declines when DP becomes negative. ;. DP increases in the beginning! reaches the highest point and diminishes at the end. <. AP will also have the same tendencies as the DP. In the beginning DP will be higher than AP but at the end AP will be higher than DP. Figure -1 refer !ard copy

In the above diagram along with ,9 a"is! we measure the amount of variable factors employed and along ,L a"is! we measure TP! AP $ DP. (rom the diagram it is clear that there are III stages. 'tage 3u*&er I. (!e .a# 1f Increasing /eturns The total output increases at an increasing rate -Dore than proportionately. up to the point P because corresponding to this point P the DP is rising and reaches its highest point. After the point P! DP decline and as such TP increases gradually. The first stage comes to an end at the point where DP curve cuts the AP curve when the AP is ma"imum at /. The stage I is called as the law of increasing returns on account of the following reasons.

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:. The proportion of fi"ed factors is greater than the uantity of variable factors. %hen the producer increases the uantity of variable factor! intensive and effective utili#ation of fi"ed factors become possible leading to higher output. ;. %hen the producer increases the uantity of variable factor! output increases due to the complete utili#ation. of the Indivisible (actors <. As more units of the variable factor is employed! the efficiency of variable factors will go up because it creates more opportunity for the introduction of division of labor and speciali#ation resulting in higher output. 'tage 3u*&er II (!e .a# 1f 5i*inis!ing /eturns In this case as the uantity of variable inputs is increased to a given uantity of fi"ed factors! output increases less than proportionately. In this stage! the T.P increases at a diminishing rate since both AP $ DP are declining but they are positive. The II stage comes to an end at the point where TP is the highest at the point * and DP is #ero at the point =. It is known as the stage of ?iminishing @eturns because both the AP $ DP of the variable factor continuously fall during this stage. It is only in this stage! the firm is ma"imi#ing its total output. 5i*inis!ing returns arise due to the following reasons) :. The proportion of variable factors are greater than the uantity of fi"ed factors. 'ence! both AP $ DP decline. ;. Total output diminishes because there is a limit to the full utili#ation of indivisible factors and introduction of speciali#ation. 'ence! output declines. <. ?iseconomies of scale will operate beyond the stage of optimum production. G. Imperfect substitutability of factor inputs is another cause. Mp to certain point substitution is beneficial. ,nce optimum point is reached! the fi"ed factors cannot be compensated by the variable factor. ?iminishing returns are bound to appear as long as one or more factors are fi"ed and cannot be substituted by the others.

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(!e III 'tage (!e 'tage 1f 3egati7e /eturns. In this case! as the uantity of variable input is increased to a given uantity of fi"ed factors! output becomes negative. ?uring this stage! TP starts diminishing! AP continues to diminish and DP becomes negative. The negative returns are the result of e"cessive uantity of variable factors to a constant uantity of fi"ed factors. 'ence! output declines. The proverb Too many cooks spoil the broth and Too much is too bad aptly applies to this stage. Aenerally! the III stage is a theoretical possibility because no producer would like to come to this stage. The producer being rational will not select either the stage I -because there is opportunity for him to increase output by employing more units of variable factor. or the III stage -because the DP is negative.. The stage I $ III is described as /on economic @egion or Mneconomic @egion. 'ence! the producer will select the II stage -which is described as the most economic region. where he can ma"imi#e the output. The II stage represents the range of rational production decision. It is clear that in the abo!e e"ample, the most ideal or optimum combination of factor units ' ( &cre of land) *s. +,,,-,, capital and . laborers. All the < stages together constitute the law of variable proportions. 3ince the second stage is the most important! in practice we normally refer this law as the law of ?iminishing @eturns.

3.3.2 Practical application of t!e la#

:. It helps a producer to work out the most ideal combination of factor inputs or the least cost combination of factor inputs. ;. It is useful to a businessman in the short run production planning at the micro0level. <. The law gives guidance that by making continuous improvements in science and technology! the producer can postpone the occurrence of diminishing returns.

3.3.3 Concept of Production functions 0 The Dain concepts of Production (unctions are)
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:. The marginal productivity of factors of production. ;. The marginal rate of technical substitution. <. *lasticity of substitution G. (actor intensity B. The returns to scale.

Darginal Product of (actors The marginal product of a factor of production is defined as a change in output due to a very small change in the uantity of this factor while uantities of all other factors of production remain constant.

3.3.- Marginal rate of tec!nical su&stitution

NThe marginal rate of technical substitution of labour for capital is that uantity of capital which has to be reduced on an increase in the use of labour by one unit to keep the level of production constant. Table showing Darginal @ate of Technical 3ubstitution *lasticity of Technical 3ubstitution NThe elasticity of technical substitution is defined as the percentage change in the ratio of the two factors of production -say! capital 8 labour ratio.! divided by the percentage change in the marginal rate of technical substitution. percentage change in 6E+ N*s 5 percentage change in D@T3+6 (actor Intensity In any process! if only two factors -e.g.! capital and labour. are used! the factor intensity refers to capital0labour ratio. If 6:E+: O 6;E+; it shows that the former process is more capital intensive than the latter.

3.3.0 /eturns to 'cale

N&ommonly used Aeneral Production (unction) 9 5 f -+! 6! v! u . +aw of ?iminishing Darginal @eturns Darshall stated this law as follows) An increase in capital and labour applied in the cultivation of land causes in general a less than proportionate increase in the amount of produce raised! unless it happens to coincide with an improvement in the arts of agriculture.
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In the initial stages of cultivation of a given piece of land! perhaps due to under0 cultivation of land! when additional units of capital and labour are invested! additional output may be more than proportionate. =ut after a certain e"tent when the land is cultivated with some more investment! the additional output will be less than proportionate under all normal circumstances! unless some improvements take place in the methods of techni ues of cultivation. . The law is applicable to all fields of production such as industry! mining! house construction! besides agriculture.

Assu*ptions of t!e .a# of 5i*inis!ing Marginal /eturns

The law of diminishing marginal returns holds good subject the following two conditions)0 N:. 3ame technology is used throughout the process of production. %hatever change takes place in the proportion of factor inputs is within the scope of available methods and techni ues. N;. Mnits of different factor inputs are perfectly homogeneous2 every unit is of e ual efficiency and therefore! are interchangeable with any other factor input in the production function.

a. .a# of %aria&le Proportions NProf. =enham states the law as follows) As the proportion of one factor in a combination of factors is increased after a point! the average and marginal production of that factor will diminish. A. P. 3tigler) NAs e ual increments of one input are added! the inputs of other productive services being held constant! beyond a certain point the resulting increments of product will decrease! i.e. the marginal product will diminish.

NThe law is summarised thus)NIn the short run! as the amount of variable factors increases! other things remaining e ual! output -or the returns to the factors varied. will increase

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more than proportionately to the amount of variable inputs in the beginning! then it may increase in the same proportion and ultimately it will increase less proportionately. &. .a# of %aria&le Proportions NThe conditions underlying the law are ) ,nly one factor is varied2 all other factors remain constant. The scale of output is unchanged and production capacity remains constant. Techni ue of production is unchanged. All units of factor input varied! are homogeneous 8 all units have identical efficiencies and characteristics. All factors of production cannot be substituted for one another. Deasurements of the Product

c. (otal Product Total number of units produced per unit of time by all factor inputs in referred to as total product. In the short run! since Total Product -output.-TP. increases with an increase in the 4uantity of >ariable (actor -4>(.! TP 5 f-4>(.. NAverage Product) Average Product refers to the total product per unit of the given variable factor. AP 5 TPE4>( NDarginal Product) ,wing to the addition of a unit to a variable factor! all other factors being held constant! the additional realised in the total product is technically called marginal product. QDPn 5 TPn 8 TPn0: Q :.3tage I 8 The law of diminishing returns becomes evident in the marginal product line. Initially the marginal product of the variable input -labour. rises. The total product rises at an increasing rate -5marginal product.. Average product also rises. This is the stage of increasing returns. ;.3tage II 8 @eaching a certain point! the marginal product begins to diminish. Thus! the rate of increase in the total output slows down. This is the stage of diminishing returns. %hen the
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average product is ma"imum! the average product is e ual to the marginal product. <.3tage III 8 As the marginal product tends to diminish! it ultimately becomes #ero and negative thereafter. N%hen the marginal product becomes #ero! the total product is the ma"imum. Thus when marginal product becomes negative! the total product begins to decline in the same proportion. *ven though AP is decreasing! it does not become negative immediately.

3.3.8 '!ort-run %ersus .ong-run Production function

The short run and the long run have no calendrical specificity. These are only functional and analytical period0wise classification. The 3hort0run is that period of time in which at least one of the factors of production remains fi"ed. %hereas! the +ong0run is that period of time in which all factors are variable. The major determinant of the short0run or long0run time periods is the e"istence or non0e"istence of fi"ed input. %hen one or more inputs remain constant we consider that period of time as short period2 whereas when all inputs are capable of being varied that period is regarded as the long0period. If we consider a simple production function with two inputs labour -l. and capital -k. and only one output -4.

Then we can summari#e the short0run production function as) 4 5 f -l!k . ,r 4 5 f -l ! k. %hen the bar above k or l shows that the amount of that input is fi"ed.
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The long0run production function may be summari#ed as 4 5 f -l! k. %here both labour and capital are variable inputs. 3ince in short0run! not all inputs can be varied simultaneously! the proportions in which inputs are combined go on varying. There fore the analysis of input0output relation depicted by the short0run production function is called the @eturns to >ariable Proportions. It takes shape in the +aws of @eturns. %hereas the long0run production function gives the input0output relationship when all inputs are varied. In fact economists are particularly interested in finding out as to what happens to the output when all inputs are varied proportionately. This analysis of relationship between proportionate change in inputs and the resulting output gives rise to proportionate change in inputs and the resulting output gives rise to @eturns to 3cale.

3.3.9 .a#s of returns and returns to scale

/eturns to scale: returns to scale! in economics! the uantitative change in output of a firm or industry resulting from a proportionate increase in all inputs. If the uantity of output rises by a greater proportionRe.g.! if output increases by ;.B times in response to a doubling of all inputsRthe production process is said to e"hibit increasing returns to scale. 3uch economies of scale may occur because greater efficiency is obtained as the firm moves from small0 to large0 scale operations. ?ecreasing returns to scale occur if the production process becomes less efficient as production is e"panded! as when a firm becomes too large to be managed effectively as a single unit. In economics! returns to scale and economies of scale are related terms that describe what happens as the scale of production increases in the long run! when all input levels including physical capital usage are variable -chosen by the firm.. They are different terms and should not be used interchangeably. The term returns to scale arises in the conte"t of a firmSs production function. It refers to changes in output resulting from a proportional change in all inputs -where all inputs increase by a constant factor.. If output increases by that same proportional change then there are constant returns to scale -&@3.. If output increases by less than that proportional change! there
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are decreasing returns to scale -?@3.. If output increases by more than that proportional change! there are increasing returns to scale -I@3.. Thus the returns to scale faced by a firm are purely technologically imposed and are not influenced by economic decisions or by market conditions. A firmSs production function could e"hibit different types of returns to scale in different ranges of output. Typically! there could be increasing returns at relatively low output levels! decreasing returns at relatively high output levels! and constant returns at one output level between those ranges. An economic concept referring to a situation in which economies of scale no longer function for a firm. @ather than e"periencing continued decreasing costs per increase in output! firms see an increase in marginal cost when output is increased. )$a*ple %hen all inputs increase by a factor of ;! new values for output will be) Twice the previous output if there are constant returns to scale -&@3. +ess than twice the previous output if there are decreasing returns to scale -?@3. Dore than twice the previous output if there are increasing returns to scale -I@3.

Assuming that the factor costs are constant -that is! that the firm is a perfect competitor in all input markets.! a firm e"periencing constant returns will have constant long0run average costs! a firm e"periencing decreasing returns will have increasing long0run average costs! and a firm e"periencing increasing returns will have decreasing long0run average costs. 'owever! this relationship breaks down if the firm is not a perfect competitor in the input markets. (or e"ample! if there are increasing returns to scale in some range of output levels! but the firm is so big in one or more input markets that increasing its purchases of an input drives up the inputSs per0unit cost! then the firm could have diseconomies of scale in that range of output levels. &onversely! if the firm is able to get bulk discounts of an input! then it could have
23

economies of scale in some range of output levels even if it has decreasing returns in production in that output range. 3et#or+ effect /etwork e"ternalities resemble economies of scale! but they are not considered such because they are a function of the number of users of a good or service in an industry! not of the production efficiency within a business. *conomies of scale e"ternal to the firm -or industry wide scale economies. are only considered e"amples of network e"ternalities if they are driven by demand side economies. For*al definitions (ormally! a production function is defined to have) constant returns to scale if -for any constant a greater than or e ual to :. increasing returns to scale if -for any constant a greater than :. decreasing returns to scale if -for any constant a greater than :. where 6 and + are factors of production! capital and labor! respectively.

For*al e$a*ple The &obb0?ouglas functional form has constant returns to scale when the sum of the e"ponents adds up to one. The function is) where A O C and C T b T :. Thus =ut if the &obb0 ?ouglas production function has its general form with C T c T :! then there are increasing returns if b F c O : but decreasing returns if b F c T :! since which is greater than or less than a(-6!+. as bFc is greater or less than one.

3.- .A ' 1F /)(U/3'

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The relationship between the inputs and the output in the process of production is clearly e"plained by the +aws of @eturns or the +aw of >ariable Proportions.This law e"amines the production function with only one factor variable! keeping the uantities of other factors constant. The laws of returns comprise of three phases)

-a. The +aw of Increasing @eturns. -b. The +aw of &onstant @eturns. -c. The +aw of ?iminishing @eturns.

The +aws of @eturns may be stated as follows) If in any process of production! the factors of production are so combined that if the varying uantity of one factor is combined with the fi"ed uantity of other factor -or factors.! then there will be three tendencies about the additional output or marginal returns) -i. (irstly! in the beginning! as more and more units of a variable factor are added to the units of a fi"ed factor! the additional output or Darginal @eturns will go on increasing. 'ere we have the +aw of Increasing @eturns operating. -ii. 3econdly! if still more units of variable factor inputs are added to the units of a fi"ed factor! the additional output or marginal returns will remain constant. The +aw of &onstant @eturns begins to operate2 and -iii. (inally! if still more units of variable factors are fed into the process of production! then the additional output or marginal returns begins to decline. Thus! eventually! we have the operation of the +aw of ?iminishing @eturns. %e can best illustrate these three stages of +aw of @eturns with the help of a model. +et us assume that a farmer has a fi"ed si#e of land! say one

3.-.1 )cono*ies of 'cale

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The study of economies of scale is associated with large scale production. Today there is a general tendency to organi#e production on a large scale basis. Dass production of standardi#ed goods has become the order of the day. +arge scale production is beneficial and economical in nature. The ad!antages or benefits that accrue to a firm as a result of increase in its scale of production are called /0conomies of scale1 . They have close relationship with the si#e of the firm. They influence the average cost over different ranges of output. They are gain to a firm. They help in reducing production cost and establishing an optimum si#e of a firm. Thus! they help a lot and go a long way in the development and growth of a firm. According to Prof. Darshall these economies are of two types! vi# Internal *conomies and *"ternal *conomics. I. Internal )cono*ies or /eal )cono*ies Internal *conomies are those economies which arise because of the actions of an individual firm to economi#e its cost. They arise due to increased division of labor or speciali#ation and complete utili#ation of indivisible factor inputs. Prof. &airncross points out that internal economies are open to a single factory or a single firm independently of the actions of other firms. They arise on account of an increase in the scale of output of a firm and cannot be achieved unless output increases. The following are some of the important aspects of internal economies. :. They arise with in or inside a firm. ;. They arise due to improvements in internal factors. <. They arise due to specific efforts of one firm. G. They are particular to a firm and enjoyed by only one firm. B. They arise due to increase in the scale of production. I. They are dependent on the si#e of the firm. K. They can be effectively controlled by the management of a firm. J. They are called as =usiness 3ecrets of a firm.

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3.-.2 ;inds of Internal )cono*ies

1. (ec!nical )cono*ies These economies arise on account of technological improvements and its practical application in the field of business. *conomies of techni ues or technical economies are further subdivided into five heads. a. )cono*ies of superior tec!ni<ues) These economies are the result of the application of the most modern techni ues of production. %hen the si#e of the firm grows! it becomes possible to employ bigger and better types of machinery. The latest and improved techni ues give place for speciali#ed production. It is bound to be cost reducing in nature. (or e"ample! cultivating the land with modern tractors instead of using age old wooden ploughs and bullock carts! use of computers instead of human labor etc. &. )cono*ies of increased di*ension= It is found that a firm enjoys the reduction in cost when it increases its dimension. A large firm avoids wastage of time and economi#es its e"penditure. Thus! an increase in dimension of a firm will reduce the cost of production. (or e"ample! operation of a double decker instead of two separate buses. c. )cono*ies of lin+ed process= It is uite possible that a firm may not have various processes of production with in its own premises. Also it is possible that different firms through mutual agreement may decide to work together and derive the benefits of linked processes. (or e"ample! in diary farming! printing press! nursing homes etc. d. )cono*ies arising out of researc! and &y products= A firm can invest ade uate funds for research and the benefits of research and its costs can be shared by all other firms. 3imilarly! a large firm can make use of its wastes and byproducts in the most economical manner by producing other products.
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(or e"ample! cane pulp! molasses! and abases of sugar factory can be used for the production of paper! varnish distilleries etc. e. In7entory )cono*ies= Inventory management is a part of better materials management. A big firm can save a lot of money by adopting latest inventory management techni ues. (or e"ample! Pust0In0Time or #ero level inventory techni ues. The rationale of the Pust0in0Time techni ue is that instead of having huge stocks worth of lakhs and &rores of rupees! it can ask the seller of the inputs to supply them just before the commencement of work in the production department each day. ;. Managerial )cono*ies. They arise because of better! efficient! and scientific management of a firm. 3uch economies arise into different ways. a. 5elegation of details= The general manager of a firm cannot look after the working of all processes of production. In order to keep an eye on each production process he has to delegate some of his powers or functions to trained or speciali#ed personnel and thus relieve himself for coordination! planning and e"ecuting the plans. This will enable him to bring about improvements in production process and in bringing down the cost of production. &. Functional 'peciali>ation= It is possible to secure economies of large scale production by dividing the work of management into several separate departments. *ach department is placed under an e"pert and the rest of the work is left into the hands of specialists. This will ensure better and more efficient productive management with scientific business administration. This would lead to higher efficiency and reduction in the cost of production. <. Mar+eting or Co**ercial econo*ies)
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These economies ill arise on account of buying and selling goods on large scale basis at fa!orable terms. A large firm can buy raw materials and other inputs in bulk at concessional rates. As the bargaining capacity of a big firm is much greater than that of small firms! it can get uantity discounts and rebates. In this way economies may be secured in the purchase of different inputs. A firm can reduce its selling costs also. A large firm can have its own sales agency and channel. The firm can have a separate selling organi#ation! marketing department manned by e"perts who are well versed in the art of pushing the products in the market. It can follow an aggressive sales promotion policy to influence the decisions of the consumers G. Financial )cono*ies= They arise because of the ad!antages secured by a firm in mobilizing huge financial resources. A large firm on account of its reputation! name and fame can mobili#e huge funds from money market! capital market! and other private financial institutions at concessional interest rates. It can borrow from banks at relatively cheaper rates. It is also possible to have large overdrafts from banks. A large firm can float debentures and issue shares and get subscribed by the general public. Another advantage will be that the raw material suppliers! machine suppliers etc.! are willing to supply material and components at comparatively low rates! because they are likely to get bulk orders. Thus! a big firm has an edge over small firms in securing sufficient funds more easily and cheaply. B. .a&or )cono*ies= These economies ill arise as a result of employing s#illed, trained, %ualified and highly e"perienced persons by offering higher ages and salaries. As a firm e"pands! it can employ a large number of highly talented persons and get the benefits of speciali#ation and division of labor. It can also impart training to e"isting labor force in order to raise skills! efficiency and productivity of workers. /ew schemes may be chalked out to speed up the work! conserve the scarce resources! economi#e the e"penditure and save labor time. It can provide better working
29

conditions promotional opportunities! rest rooms! sports rooms etc! and create facilities like subsidi#ed canteen! crUches for infants! recreations. All these measures will definitely raise the average productivity of a worker and reduce the cost per unit output. I. (ransport and 'torage )cono*ies= They arise on account of the pro!ision of better, highly organized and cheap transport and storage facilities and their complete utilization. A large company can have its own fleet of vehicles or means of transport which are more economical than hired ones. 3imilarly! a firm can also have its own storage facilities which reduce cost of operations. K. 17er 2ead )cono*ies= These economies ill arise on account of large scale operations. The e"penses on establishment! administration! bookkeeping! etc! are more or less the same whether production is carried on small or large scale. 'ence! cost per unit will be low if production is organi#ed on large scale. ?. )cono*ies of %ertical integration= & firm can also reap this benefit hen it succeeds in integrating a number of stages of production. It secures the advantages that the flow of goods through various stages in production processes is more readily controlled. =ecause of vertical integration! most of the costs become controllable costs which help an enterprise to reduce cost of production. H. /is+ &earing or sur7i7al econo*ies= These economies ill arise as a result of a!oiding or minimizing se!eral #inds of ris#s and uncertainties in a business. A manufacturing unit has to face a number of risks in the business. Mnless these risks are effectively tackled! the survival of the firm may become! difficult. 'ence many steps are taken by a firm to eliminate or to avoid or to minimi#e various kinds of risks. Aenerally speaking! the risk0bearing capacity of a big firm will be much greater than that of a small firm. @isk is avoided when few firms amalgamate or join together or when competition between different firms is either eliminated or reduced to the minimum or e"panding
30

the si#e of the firm. A large firm secures risk0spreading advantages in either of the four ways or through all of them. 5i7ersification of output Instead of producing only one particular variety! a firm has to produce multiple products if there is loss in one item it can be made good in other items. 5i7ersification of *ar+et) Instead of selling the goods in only one market! a firm has to sell its products in different markets. If consumers in one market desert a product! it can cover the losses in other markets. 5i7ersification of source of supply) Instead of buying raw materials and other inputs from only one source! it is better to purchase them from different sources. If one person fails to supply! a firm can buy from several sources. 5i7ersification of t!e process of *anufacture ) Instead adopting only one process of production to manufacture a commodity! it is better to use different processes or methods to produce the same commodity so as to avoid the loss arising out of the failure of any one process.

II. )$ternal )cono*ies or Pecuniary )cono*ies

0"ternal economies are those economies hich accrue to the firms as a result of the e"pansion in the output of hole industry and they are not dependent on the output le!el of indi!idual firms. These economies or gains will arise on account of the overall growth of an industry or a region or a particular area. They arise due to benefit of locali#ation and speciali#ed progress in the industry or region. Prof. 3tonier $ 'ague points out that e"ternal economies are those economies in production which depend on increase in the output of the whole industry rather than increase in the output of the individual firm The following are some of the important aspect of e"ternal economies. :. They arise Voutside1 the firm. ;. They arise due to improvement in e"ternal factors. <. They arise due to collective efforts of an industry. G. They are general! common $ enjoyed by all firms.
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B. They arise due to overall development! e"pansion $ growth of an industry or a region. I. They are dependent on the si#e of industry. K. They are beyond the control of management of a firm. J. They are called as open secrets of a firm.

3.-.3 ;inds of )$ternal )cono*ies

1. )cono*ies of concentration or Agglo*eration They arise because in a particular area a !ery large number of firms hich produce the same commodity are established. In other words! this is an advantage which arises from what is called V+ocali#ation of Industry1. The following benefits of locali#ation of industry is enjoyed by all the firms provision of better and cheap labor at low or reasonable rates! trained educated and skilled labor! transport and communication! water! power! raw materials financial assistance through private and public institutions at low interest rates! marketing facilities! benefits of common repairs! maintenance and service shops! services of specialists or outside e"perts! better use of byproducts and other such benefits. Thus! it helps in reducing the cost of operation of a firm. 2. )cono*ies of Infor*ation These economies ill arise as a result of getting %uic#, latest and up to date information from !arious sources. Another form of benefit that arises due to locali#ation of industry is economies of information. 3ince a large number of firms are located in a region! it becomes possible for them to e"change their views fre uently! to have discussions with others! to organi#e lectures! symposiums! seminars! workshops! training camps! demonstrations on topics of mutual interest. @evolution in the field of information technology! e"pansion in inter net facilities! mobile phones! emails! video conferences! etc has helped in the free flow of latest information from all parts of the globe in a very short span of time. 3imilarly! publication of journals! maga#ines! information papers etc have helped a lot in the dissemination of uick information. 3tatistical! technical and other market information becomes more readily available to all firms. This will help in developing contacts between different firms. %hen inter0firm relationship strengthens! it helps a lot to economi#e the e"penditure of a single firm.
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3. )cono*ies of 5isintegration These economies ill arise as a result of di!iding one big unit in to different small units for the sa#e of con!enience of management and administration. %hen an industry grows beyond a limit! in that case! it becomes necessary to split it in to small units. /ew subsidiary units may grow up to serve the needs of the main industry. (or e"ample! in cotton te"tiles industry! some firms may speciali#e in manufacturing threads! a few others in printing! and some others in dyeing and coloring etc. This will certainly enhance the efficiency in the working of a firm and cut down unit costs considerably. -. )cono*ies of @o7ern*ent Action These economies ill arise as a result of acti!e support and assistance gi!en by the go!ernment to stimulate production in the pri!ate sector units. In recent years the government! in order to encourage the development of private industries have come up with several kinds of assistance. It is granting ta" concessions! ta" holidays! ta" e"emptions! subsidies! development rebates financial assistance at low interest rates! etc. It is uite clear from the above detailed description that both internal and e"ternal economies arise on account of large scale production and they are benefits to a firm and cost reducing in nature. 0. )cono*ies of P!ysical Factors These economies ill arise due to the a!ailability of fa!orable physical factors and en!ironment. As the si#e of an industry e"pands! positive physical environment may to reduce the costs of all firms working in the industry. (or e"ample! &limate! weather conditions! fertility of the soil! physical environment in a particular place may help all firms to enjoy certain physical benefits. 8. )cono*ies of elfare These economies ill arise on account of !arious elfare programs under ta#en by an industry to help its o n staff. A big industry is in a better position to provide
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welfare facilities to the workers. It may get land at concessional rates and procure special facilities from the local governments for setting up housing colonies for the workers. It may also establish health care units! training centers! computer centers and educational institutions of all types. It may grant concessions to its workers. All these measures would help in raising the overall efficiency and productivity of workers.

3.-.- 5isecono*ies of 'cale

%hen a firm e"pands beyond the optimum limit! economies of scale will be converted in to diseconomies of scale. ,ver growth becomes a burden. 'ence! one should not cross the limit. ,n account of diseconomies of scale! more output is obtained at higher cost of production. The following are some of the main diseconomies of scale 1. Financial disecono*ies= As there is over growth! the re uired amount of fiancWe may not be available to a firm. &onse uently! higher interest rates are to be paid for additional funds. 2. Managerial disecono*ies= *"cess growth leads to loss of effective supervision! control management! coordination of factors of production leading to all kinds of wastages! indiscipline and rise in production and operating costs. 3. Mar+eting disecono*ies= Mnplanned e"cess production may lead to mismatch between demand and supply of goods leading to fall in prices. 3tocks may pile up! sales may decline leading to fall in revenue and profits. -. (ec!nical disecono*ies=

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%hen output is carried beyond the plant capacity! per unit cost will certainly go up. There is a limit for division of labor and speciali#ation. =eyond a point! they become negative. 'ence! operation costs would go up. 0. 5isecono*ies of ris+ and uncertainty &earing= If output e"pends beyond a limit! investment increases. The level of inventory goes up. 3ales do not go up correspondingly. =usiness risks appear in all fields of activities. 3upply of factor inputs become inelastic leading to high prices. 8. .a&or disecono*ies= An unwieldy firm may become impersonal. &ontact between labor and management may disappear. %orkers may demand higher wages and salaries! bonus and other such benefits etc. Industrial disputes may arise. +abor unions may not cooperate with the management. All of them may contribute for higher operation costs. II )$ternal disecono*ies. %hen several business units are concentrated in only place or locality! it may lead to congestion!! environmental pollution! scarcity of factor inputs like! raw materials! water! power! fuel! transport and communications etc leading to higher production and operational costs. Thus! it is very clear that a firm can enjoy benefits of large scale production only up to a limit. =eyond the optimum limit! it is bound to e"perience diseconomies of scale. 'ence! there should be proper check on the growth and e"pansion of a firm.

3.-.0 Internalisation of )$ternal )cono*ies

It implies that a firm will convert certain e"ternal benefits created by the government or the entire society to its own favor with out making any additional investments. A firm may start a new unit in between two big railway stations or near the air port or near the national high ways or a port so that it can enjoy all the infrastructure benefits. 3imilarly! a new computer firm can commence its operations where there is ;G hours supply of electricity. 'ence!
35

they are also called as privati#ation of public benefits. 3uch type of efforts is to be encouraged by the government.

3.-.8 )$ternalisation of Internal 5isecono*ies

In this case! a particular firm on account of its regular operations will pass on certain costs on the entire society. A firm instead of taking certain precautionary measures by spending some amount of money will escape and pass on this burden to the government or the society. (or e"ample! a firm may throw chemical or industrial wastes! dirt and filth either to open air or rivers leading to environmental pollution. In that case! the government is forced to spend more money to clean river water or prevent environmental pollution. This is a clear case of e"ternali#ed internal diseconomies. It is to be avoided at all costs.

3.0 Production opti*i>ation

Benefits :. An accurate forecast of future cash flows and associated risks ;. &ost savings by avoiding unnecessary attention to areas that are non0critical! and improved focus on areas of higher value <. ?iscovery of enhancement opportunities during the conceptual and design phase! rather than later in the project1s life0cycle! when the cost of change is considerably higher G. 3ystematic identification of key technological risks for a specific concept! and setting of priorities for further technology development! ualification and testing -to reduce and manage these risks. B. Improved insight into technical and managerial issues that may cause critical failures and production losses
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I. A road map on how to improve production capacities and production availability based on risk and cost0benefit assessments. I*portant para*eters include a. Production capacity profiles b. ?emand profiles and product prices c. Physical asset layout and design d. * uipment reliability performance e. Daintenance and repair activities including spare part strategies f. ,peration and mobilisation activities.

3.8 Iso<uant

In economics! an iso uant -derived from uantity and the Areek word iso! meaning e ual. is a contour line drawn through the set of points at which the same uantity of output is produced while changing the uantities of two or more inputs. %hile an indifference curve mapping helps to solve the utility0ma"imi#ing problem of consumers! the iso uant mapping deals with the cost0minimi#ation problem of producers. Iso uants are typically drawn on capital0labor graphs! showing the technological tradeoff between capital and labor in the production function! and the decreasing marginal returns of both inputs. Adding one input while holding the other constant eventually leads to decreasing marginal output! and this is reflected in the shape of the iso uant. A family of iso uants can be represented by an iso uant map! a graph combining a number of iso uants! each representing a different uantity of output. Iso uants are also called e ual product curves.

3.8.1 I'1,UA3(' A35 I'1C1'('

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The prime concern of a firm is to workout the cheapest factor combinations to produce a given uantity of output. There are a large number of alternative combinations of factor inputs which can produce a given uantity of output for a given amount of investment. 'ence! a producer has to select the most economical combination out of them. Isoproduct curve is a techni ue developed in recent years to show the e uilibrium of a producer with two variable factor inputs. It is a parallel concept to the indifference curve in the theory of consumption. 3.8.2 M)A3I3@ A35 5)FI3I(I13' The term Iso Quant has been derived from Iso meaning e!ua" and Quant meaning !uantit#. $ence, Iso Quant is a"so ca""ed as %!ua" Product &urve or Product Indifference &urve or &onstant Product &urve. An Iso 'roduct curve re'resents a"" the 'ossib"e combinations of two factor in'uts which are ca'ab"e of 'roducing the same "eve" of out'ut. It ma# be defined as a curve which shows the different combinations of the two in'uts 'roducing the same "eve" of out'ut . %ach Iso Quant curve re'resents on"# one 'articu"ar "eve" of out'ut. If there are different IsoQuant curves, the# re'resent different "eve"s of out'ut. An# 'oint on an IsoQuant curve re'resents same "eve" of out'ut. (ince each 'oint indicates e!ua" "eve" of out'ut, the 'roducer becomes indifferent with res'ect to an# one of the combinations.

!at are Iso<uants" I3, 8 means e ual! 4MA/T 8 means uantity. Iso uant literally means * ual 4uantity. Iso uant curve can also be called Isoproduct curve. This curve represents e ual uantity of output produced using various combinations of inputs. An Iso uant is the locus of all the combinations of two factors of production that yield the same level of output. . Assu*ptions of Iso<uants
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:. It is generally assumed that there are only two factors or inputs of production. ;. The factors of production are divisible into small units and can be used in any proportion. <. Technical conditions of production are given and cannot be changed. G. Aiven the technical conditions of production! different factors are used in the most efficient manner.Properties of Iso uants a. Iso uants are negatively sloped i.e.!slope downward from left to right. b. A higher Iso uant represents a larger output. c. /o two Iso uants intersect each other. d. Iso uants are conve" to the origin. 0 because the marginal rate of technical substitution tends to fall. Types of Iso uants

An iso uant shows the e"tent to which the firm in uestion has the ability to substitute between the two different inputs at will in order to produce the same level of output. An iso uant map can also indicate decreasing or increasing returns to scale based on increasing or decreasing distances between the iso uant pairs of fi"ed output increment! as output increases. If the distance between those iso uants increases as output increases! the firmSs production function is e"hibiting decreasing returns to scale2 doubling both inputs will result in placement on an iso uant with less than double the output of the previous iso uant. &onversely! if the distance is decreasing as output increases! the firm is e"periencing increasing returns to scale2 doubling both inputs results in placement on an iso uant with more than twice the output of the original iso uant. As with indifference curves! two iso uants can never cross. Also! every possible combination of inputs is on an iso uant. (inally! any combination of inputs above or to the right of an iso uant results in more output than any point on the iso uant. Although the marginal product of an input decreases as you increase the uantity of the input while holding all other inputs constant! the marginal product is never negative in the empirically observed range since a rational firm would never increase an input to decrease output.
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Figure refer !ard copy

An iso uant map where 4< O 4; O 4:. A typical choice of inputs would be labor for input 9 and capital for input L. Dore of input 9! input L! or both is re uired to move from iso uant 4: to 4;! or from 4; to 4<. Figure refer !ard copy

3.8.3 Production Iso<uantAIsocost Cur7e

:. *"ample of an iso uant map with two inputs that are perfect substitutes. Figure refer !ard copy

;. *"ample of an iso uant map with two inputs that are perfect complements. Figure !ard copy

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3.8.- '!apes of Iso<uants

If the two inputs are perfect substitutes! the resulting iso uant map generated is represented in fig. A2 with a given level of production 4<! input 9 can be replaced by input L at an unchanging rate. The perfect substitute inputs do not e"perience decreasing marginal rates of return when they are substituted for each other in the production function. If the two inputs are perfect complements! the iso uant map takes the form of fig. =2 with a level of production 4<! input 9 and input L can only be combined efficiently in the certain ratio occurring at the kink in the iso uant. The firm will combine the two inputs in the re uired ratio to ma"imi#e profit. Iso uants are typically combined with isocost lines in order to solve a cost0 minimi#ation problem for given level of output. In the typical case shown in the top figure! with smoothly curved iso uants! a firm with fi"ed unit costs of the inputs will have isocost curves that are linear and downward sloped2 any point of tangency between an iso uant and an isocost curve represents the cost0minimi#ing input combination for producing the output level associated with that iso uant. The only relevant portion of the iso uant is the one that is conve" to the origin! part of the curve which is not conve" to the origin implies negative marginal product for factors of production. 'igher I3,04uant higher the production Iso<uants The word SI3,S is of Areek origin and means e ual or same and S uantS means uantity. An iso uant may be defined as a curve showing all the various combinations of two factors that can produce a given level of output. The iso uant shows the whole range of alternative ways of producing the same level of output. The modern economists are using iso uant! or XI3,X product curves for determining the optimum factor combination to produce certain units of a commodity at the least cost. The concept of iso uant or e ual product curve can be better e"plained with the help of .schedule given below) Iso<uant 'c!edule
41

&ombinations (actor 9 A = & ? * B : ; < G

(actor L :G :C K B G

Total ,utput :CC D*T*@ :CC D*T*@ :CC D*T*@ :CC D*T*@ :CC D*T*@

In the table given above! it is shown that a producer employs two factors of production 9 and L for producing an output of :CC meters of cloth. There are five combinations which produce the same level of output -:CC meters of cloth.. The factor combination A using : unit of factor 9 and :G units of factor L produces :CC meters of cloth. The combination = using ; units of factor 9 and :C units of factor L produces :CC meters of cloth. 3imilarly combinations &! M and *! employing < units of 9 and K units of L! G units of 9 and B units of L! B units of 9 and G units of L produce :CC units of output! each. The producer! here! is indifferent as to which combination of inputs he uses for producing the same amount of output. The alternative techni ues for producing a given level of output can be plotted on a graph. Figure refer !ard copy

The figure: shows y the :CC units iso uant plotted to I3, product schedule. The five factor combinations of 9 and L are plotted and are shown by points a! b! c! d and e. if we join these points! it forms an Siso uantS. An iso uant therefore! is the graphic representation of an iso0product schedule. It may here be noted that all the factor combinations of 9 and L on an iso product curve are technically efficient combinations. The producer is indifferent as to which
42

combination he uses for producing the same level of output. It is in this way that an iso product curve is also called Sproduction indifference curveS. In the figure :;.:! I3, product IP curve represents the various combinations of the two inputs which produce the same level of output -:CC meters of cloth.. Iso<uant Map An iso uant map shows a set of iso product curves. *ach iso uant represents a different level of output. A higher iso uant shows a higher level of output and a lower iso uant represents a lower level of output. Figure refer !ard copy

In the figure! a family of three Iso product curves which produce various level of output is shown. The iso product I4: yields :CC units of output by using uantities of inputs 9 and L. 3o is also the case with iso uant I4< yielding <CC units of output. %e conclude that an iso uant map includes a series! of jso0product curves. *ach iso uant represents a different level of output. The higher the iso uant output! the further right will be the iso uant. Properties of Iso<uants= The main properties of the iso uants are similar to those of indifference curves. These properties are now discussed in brief. iB An Iso<uant slopes do#n#ard fro* left to rig!t Figure refer !ard copy

43

This implies that the Iso uant is a negatively sloped curve. This is because when the uantify of factor 6 -capital. is increased! the uantity of + -labor. must be reduced so as to keep the same level of output. The figure -:;.<. depicts that an iso uant IP is negatively sloped curve. This curve shows that as the amount of factor 6 is increased from one unit to ; units! the units of factor + are decreased from ;C to :B only so that output of :CC units remains constant. CiiB An Iso<uant t!at lies a&o7e and to t!e rig!t of anot!er represents a !ig!er output le7el Figure refer !ard copy

It means a higher iso uant represents higher level of output. The figure :;.G represents this property. It shows that greater output can be secured by increasing the uantity combinations of both the factors 9 and L. The producer increases the output from :CC units to ;CC units by increasing the uantity combination of both the 9 and L. The combination of ,& of capital and ,+ of labor yield :CC units of production. The production can be increased to ;CC units by increasing the capital from ,& to ,&: and labor from ,+ to ,+:. iiiB Iso<uants cannot cut eac! ot!er Figure refer !ard copy

The two iso uants cannot intersect each other. If two iso uant are drawn to intersect each other as is shown in this figure :;.B! then it is a negation of the property that higher Iso uant represents higher level of output to a lower Iso uant. The intersection at point * shows that the same factor combination can produce :CC units as well as ;CC units. =ut this is uite absurd. 'ow can the same level of factor combination produce two different levels of
44

output! when the techni ue of production remains unchanged. 'ence two iso uants cannot intersect each other. Ci7B (!e iso<uants are con7e$ to t!e origin This property implies that the marginal significance of one factor in terms of another factor diminishes along an I3, product curve. In other words! the iso uants are conve" to the origin due to diminishing marginal rate of substitution! In this figure :;.I D@36+ diminishes from B): to G): and further to <):. This shows that as more and more units of capital -6. are employed to produce :CC units of the product! lesser and lesser units of labor -+. are used. 'ence diminishing marginal rate of technical substitution is the reason for the conve"ity of an iso uant. Figure refer !ard copy

C7B )ac! iso<uant is o7al s!aped The iso product curve! is elliptical. This means that the firm produces only those segments of the iso0product curves which are conve" to the origin and lie between the ridge lines. This is the economic region of production.

3.8.0 Isocost .ines

5efinition of Isocost .ines A firm can produce a given level of output using efficiently different combinations of two inputs. (or choosing efficient combination of the inputs! the producer selects that combination of factors which has the lower cost of production. The information about the cost can be obtained from the isocost lines.
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)$planation of Isocost .ines An isocost line is also called outlay line or price line or factor cost line. An isocost line shows all the combinations of labor and capital that are available for a given total cost to0the producer. Pust as there are infinite number of iso uants! there are infinite number of isocost lines! one for every possible level of a given total cost. The greater the total cost! the further from origin is the isocost line. The isocost line can be e"plained easily by taking a simple e"ample. +et us e"amine a firm which wishes to spend Y:CC on a combination of two factors labor and capital for producing a given level of output. %e suppose further that the price of one unit of labor is YB per day. This means that the firm can hire ;C units of labor. ,n the other hand if the price of capital is Y:C per unit! the firm will purchase :C units of capital. In the fig. :;.K! the point A shows :C units of capital used whereas point T shows ;C units of labor are hired at the given price. If we join points A and T! we get a line AT. This AT line is called isocost line or outlay line. The isocost line is obtained with an outlay of Y:CC. +et us assume now that there is no change in the market prices of the two factors labor and capitaZ but the firm increases the total outlay to Y:BC. The new price line =6 shows that with an outlay of Y:BC! the producer can purchase :B units of capital or <C units of labor. The new price line =6 3hifts upward to the right. In case the firm reduces the outlay to YBC only! the isocost line &? shifts downward to the left of original isocost line and remains parallel to the original price line. The isocost line plays a similar role in the firmSs decision making as the budget line does in consumerSs decision making. The only difference between the two is that the consumer has a single budget line which is determined by the income of the consumer. %hereas the firm faces many isocost lines depending upon the different level of e"penditure the firm might make. A firm may incur low cost by producing relatively lesser output or it may incur relatively high cost by producing a relatively large uantity.

3.8.8 (ypes of Iso<uants

46

-:. +inear Iso uant

-;. There is perfect substitutability of inputs.

-<. @ight angle Iso uant G. &onve" Iso uant

B. * ual Product curves

1. .inear iso<uant Aiven output 8 say :CC units 8 can be produced by using only capital or only labour or by a number of combinations of labour and capital. 8 both are perfectly substitutable. 2. Perfect suita&ility of inputs Aiven a power plant! e uipped to use either oil or gas! various units of electric power can be produced by burning gas only! oil only or in varying combinations of each. =oth gas and oil are perfect substitutes. +inear Iso uants ,il 3. /ig!t angle Iso<uant

'ere there is complete non0substitutability between the inputs -strictly complimentary.. (or e"ample! e"actly two wheels and one frame are re uired to produce a bicycle and wheels cannot be substituted for frames. 3imilarly! two wheels and one chassis are re uired for a scooter. This is also known as +eontief Iso uant. @ight angle Iso uant &hassis -. Con7e$ Iso<uant

This form assumes imperfect substitutability of inputs.

47

e.g. A shirt can be made with more wastage of cloth when less care -less labour. is used.-&:. If more is spent on labour! the shirt can be made with less cloth! wastage being less.-&;. If still more care is taken by spending more on labour! minimum wastage is done! by using still lesser amount of cloth.-&<. &onve" Iso uant &loth. *conomic @egion of an Iso uant %hen relatively small amount of a factor is combined with relatively large amount of another factor in an iso0 uant! in such a manner that the marginal productivity of this abundant factor tends to be negative! resulting in decline in total output. In such cases! the end portions of the curves are regarded as uneconomical. Thus when e"tended on either side! the iso0 uants are oval shaped. *conomic region of the iso0 uant is determined by drawing tangents to the curves parallel to the two a"es! and the points of tangency indicate #ero marginal productivity of the abundant factor. *conomic @egion ?ifference between * ual Product &urve -Iso uant. and Indifference &urve Indifference &urves Indifference curves indicate level of satisfaction. Indifference curves relate to combinations between two commodities. Indifference curves cannot be labelled easily as there is no numerical measurement of the satisfaction involved. ,n indifference map! between higher and lower indifference curve! the e"tent of difference in the satisfaction is not uantifiable. 0. )<ual Product cur7es * ual product curves indicate uantity of output. * ual product curves relate to combinations between two factors of production. * ual product curves can be labelled easily as physical units of output represented by it are measurable.
48

 ,n e ual product map! we can measure the e"act difference between output represented by one iso0 uant and another iso0 uant. &obb0?ouglas Production (unction &obb0 ?ouglas production function relates output in American Danufacturing industries to labour and capital inputs! taking the form P 5 a-+b&:0b. 7a and b are Fve constants. P 5 total output -production. + 5 inde" of labour employed in manufacturing & 5 inde" of fi"ed capital in manufacturing b and :0b are elasticities of production representing percentage response of output to percentage changes in labour and capital. The above stated production function is a linear and homogeneous function of degree! one which establishes constant returns to scale.

Managerial uses of production function

In microeconomics! a production function asserts that the ma"imum output of a technologically0determined production process is a mathematical production of input factors of production. &onsidering the set of all technically feasible combinations of output and inputs! only the combinations encompassing a ma"imum output for a specified set of inputs would constitute the production function. Alternatively! a production function can be defined as the specification of the minimum input re uirements needed to produce designated uantities of output! given available technology. It is usually presumed that uni ue production functions can be constructed for every production technology. =y assuming that the ma"imum output technologically possible from a given set of inputs is achieved! economists using a production function in analysis are abstracting away from the engineering and managerial problems inherently associated with a particular production process. The engineering and managerial problems of technical efficiency are assumed to be solved! so that analysis can focus on the problems of allocative efficiency. The firm is assumed to be making allocative choices concerning how much of each input factor to use! given the price of the factor and the technological determinants

49

represented by the production function. A decision frame! in which one or more inputs are held constant! may be used2 (or e"ample! capital may be assumed to be fi"ed or constant in the short run! and only labour variable! while in the long run! both capital and labour factors are variable! but the production function itself remains fi"ed! while in the very long run! the firm may face even a choice of technologies! represented by various! possible production functions. The relationship of output to inputs is non0monetary! that is! a production function relates physical inputs to physical outputs! and prices and costs are not considered. =ut! the production function is not a full model of the production process) it deliberately abstracts away from essential and inherent aspects of physical production processes! including error! entropy or waste. Doreover! production functions do not ordinarily model the business processes! either! ignoring the role of management! of sunk cost investments and the relation of fi"ed overhead to variable costs. -(or a primer on the fundamental elements of microeconomic production theory! see production theory basics.. The primary purpose of the production function is to address allocative efficiency in the use of factor inputs in production and the resulting distribution of income to those factors. Mnder certain assumptions! the production function can be used to derive a marginal product for each factor! which implies an ideal division of the income generated from output into an income due to each input factor of production.

3.9 Cost concepts

Meaning &ost is analy#ed from the producer1s point of view. &ost estimates are made in terms of money. &ost calculations are indispensable for management decisions. In the production process! a producer employs different factor inputs. These factor inputs are to be compensated by the producer for the services in the production of a
50

commodity. The compensation is the cost. The value of inputs re uired in the production of a commodity determines its cost of output. 2ost of production refers to the total money e"penses 34oth e"plicit and implicit5 incurred by the producer in the process of transforming inputs into outputs. In short! it refers total money e"penses incurred to produce a particular uantity of output by the producer. The knowledge of various concepts of costs! cost output relationship etc. occupies a prominent place in cost analysis.

3.9.1 Managerial Uses of Cost Analysis

A detailed study of cost analysis is very useful for managerial decisions. It helps the management :. To find the most profitable rate of operation of the firm. ;. To determine the optimum uantity of output to be produced and supplied. <. To determine in advance the cost of business operations. G. To locate weak points in production management to minimi#e costs. B. To fi" the price of the product. I. To decide what sales channel to use. K. To have a clear understanding of alternative plans and the right costs involved in them. J. To have clarity about the various cost concepts. H. To decide and determine the very e"istence of a firm in the production field. :C. To regulate the number of firms engaged in production. ::. To decide about the method of cost estimation or calculations. :;. To find out decision making costs by reclassifications of elements! reprising of input factors etc! so as to fit the relevant costs into management planning! choice etc.

3.9.2 5ifferent ;inds of Cost Concepts.

51

:. Money Cost and /eal Cost 6hen cost is e"pressed in terms of money, it is called as money cost. It relates to money outlays by a firm on !arious factor inputs to produce a commodity. In a monetary economy! all kinds of cost estimations and calculations are made in terms of money only. .'ence! the knowledge of money cost is of great importance in economics. *"act measurement of money cost is possible. 6hen cost is e"pressed in terms of physical or mental efforts put in by a person in the ma#ing of a product, it is called as real cost. It refers to the physical! mental or psychological efforts! the e"ertions! sacrifices! the pains! the discomforts! displeasures and inconveniences which various members of the society have to undergo to produce a commodity. It is a subjective and relative concept and hence e"act measurement is not possible. 2. I*plicit or I*puted Costs and )$plicit Costs 0"plicit costs are those costs hich are in the nature of contractual payments and are paid by an entrepreneur to the factors of production 7e"cluding himself8 in the form of rent, ages, interest and profits, utility e"penses, and payments for ra materials etc. They can be estimated and calculated e"actly and recorded in the books of accounts. Implicit or imputed costs are implied costs. They do not take the form of cash outlays and as such do not appear in the books of accounts. They are the earnings of o ner employed resources. (or e"ample! the factor inputs owned by the entrepreneur himself like capital can be utili#ed by him0self or can be supplied to others for a contractual sum if he himself does not utili#e them in the business. It is to be remembered that the total cost is a sum of both implicit and e"plicit costs. 3. Actual costs and 1pportunity Costs Actual costs are also called as outlay costs! absolute costs and ac uisition costs. They are those costs that involve financial e"penditures at some time and hence are recorded in the books of accounts. They are the actual e"penses incurred for producing or ac%uiring a commodity or ser!ice by a firm. (or e"ample! wages paid to workers! e"penses on raw materials! power! fuel and other types of inputs. They can be e"actly calculated and accounted without any
52

difficulty. Opportunity cost of a good or ser!ice is measured in terms of re!enue hich could ha!e been earned by employing that good or ser!ice in some other alternati!e uses. In other words! opportunity cost of anything is the cost of displaced alternatives or costs of sacrificed alternatives. It implies that opportunity cost of anything is the alternati!e that has been foregone. 'ence! they are also called as alternative costs. ,pportunity cost represents only sacrificed alternatives. 'ence! they can never be e"actly measured and recorded in the books of accounts. The knowledge of opportunity cost is of great importance to management decision. They help in taking a decision among alternatives. %hile taking a decision among several alternatives! a manager selects the best one which is more profitable or beneficial by sacrificing other alternatives. (or e"ample! a firm may decide to buy a computer which can do the work of :C laborers. If the cost of buying a computer is much lower than that of the total wages to be paid to the workers over a period of time! it will be a wise decision. ,n the other hand! if the total wage bill is much lower than that of the cost of computer! it is better to employ workers instead of buying a computer. Thus! a firm has to take a number of decisions almost daily. -. 5irect costs and indirect costs 9irect costs are those costs hich can be specifically attributed to a particular product, a department, or a process of production. (or e"ample! e"penses on raw materials! fuel! wages to workers! salary to a divisional manager etc are direct costs. ,n the other hand! indirect costs are those costs! which are not traceable to any one unit of operation. They cannot be attributed to a product! a department or a process. (or e"ample! e"penses incurred on electricity bill! water bill! telephone bill! administrative e"penses etc. 0. Past and future costs.

53

Past costs are those costs which are spent in the previous periods. ,n the other hand! future costs are those which are to be spent. in the future. Past helps in taking decisions for future. 8. Marginal and Incre*ental costs Darginal cost refers to the cost incurred on the production of another or one more unit .It implies additional cost incurred to produce an additional unit of output It has nothing to do with fi"ed cost and is always associated with variable cost. Incremental cost on the other hand refers to the costs involved in the production of a batch or group of output. They are the added costs due to a change in the level or nature of business activity. (or e"ample! cost involved in the setting up of a new sales depot in another city or cost involved in the production of another :CC e"tra units. 9. Fi$ed costs and 7aria&le costs. Fi"ed costs are those costs hich do not !ary ith either e"pansion or contraction in output. They remain constant irrespecti!e of the le!el of output. They are positive even if there is no production. They are also called as supplementary or over head costs. ,n the other hand! !ariable costs are those costs hich directly and proportionately increase or decrease ith the le!el of output produced . They are also called as prime costs or direct costs. ?. Accounting costs and econo*ic costs. &ccounting costs are those costs hich are already incurred on the production of a particular commodity. It includes only the ac uisition costs. They are the actual costs involved in the making of a commodity. ,n the other hand! economic costs are those costs that are to be incurred by an entrepreneur on !arious alternati!e programs. It involves the application of opportunity costs in decision making.

3.9.3 5eter*inants of Costs

&ost behavior is the result of many factors and forces. =ut it is very difficult to determine in general the factors influencing the cost as they widely differ from firm to firm and
54

even industry to industry. 'owever! economists have given some factors considering them as general determinants of costs. They have enough importance in modern business set up and decision making process. The following factors deserve our attention in this connection. 1. (ec!nology Dodern technology leads to optimum utili#ation of resources! avoid all kinds of wastages! saving of time! reduction in production costs and resulting in higher output. ,n the other hand! primitive technology would lead to higher production costs. 2. /ate of output= Ct!e degree of utili>ation of t!e plant and *ac!ineryB &omplete and effective utili#ation of all kinds of plants and e uipments would reduce production costs and under utili#ation of e"isting plants and e uipments would lead to higher production costs. 3. 'i>e of Plant and scale of production Aenerally! speaking big companies with huge plants and machineries organi#e production on large scale basis and enjoy the economies of scale which reduce the cost per unit. -. Prices of input factors 'igher market prices of various factor inputs result in higher cost of production and vice0versa. 0. )fficiency of factors of production and t!e *anage*ent 'igher productivity and efficiency of factors of production would lead to lower production costs and vice versa. 8. 'ta&ility of output 3tability in production would lead to optimum utili#ation of the e"isting capacity of plants and e uipments. It also brings savings of various kinds of hidden costs of interruption and learning leading to higher output and reduction in production costs.
55

9. .a# of returns Increasing returns would reduce cost of production and diminishing returns increase cost. ?. (i*e period In the short run! cost will be relatively high and in the long run! it will be low as it is possible to make all kinds of adjustments and readjustments in production process. Thus! many factors influence cost of production of a firm.

3.? Cost 1utput

/elations!ip= Cost Function. &ost and output are correlated. &ost output relations play an important role in almost all business decisions. It throws light on cost minimi#ation or profit ma"imi#ation and optimi#ation of output. The relation bet een the cost and output is technically described as the 2OST F:;2TIO;. The significance of cost output relationship is so great that in economic analysis the cost function usually refers to the relationship between cost and rate of output alone and we assume that all other independent variables are kept constant. Dathematically speaking T& 5 f -4. where T& 5 Total cost and 4 stands for output produced. 'owever! cost function depends on three important variables. 1 Production function If a firm is able to produce higher output with a little uantity of inputs! in that case! the cost function becomes cheaper and vice0versa. 2. (!e *ar+et prices of inputs If market prices of different factor inputs are high in that case! cost function becomes higher and vice0versa. 3. Period of ti*e
56

&ost function becomes cheaper in the long run and it would be relatively costlier in the short run. (ypes of cost function. Aenerally speaking there are two types of cost functions. :. 3hort run cost function. ;. +ong run cost function. /elations!ip and Cost cur7es in t!e '!ort-/un. It is interesting to note that the relationship between the cost and output is different at two different periods of time i.e. short run and long run. Aenerally speaking! cost of production will be relatively higher in the short run when compared to the long run. This is because a producer will get enough time to make all kinds of adjustments in the productive process in the long run than in the short run. %hen cost and output relationship is represented with the help of diagrams! we get short run and long run cost curves of the firm. /ow we shall make a detailed study of cost out put relations both in the short0run as well as in the long run. 3.?.1 M)A3I3@ 1F '21/( /U3 Short-run is a period of time in hich only the !ariable factors can be !aried hile fi"ed factors li#e plant, machinery etc remains constant. 'ence! the plant capacity is fi"ed in the short run. The total number of firms in an industry will remain the same. Time is insufficient either for the entry of new firms or e"it of the old firms. If a firm wants to produce greater uantities of output! it can do so only by employing more units of variable factors or by having additional shifts! or by having over time work for the e"isting labor force or by intensive utili#ation of e"isting stock of capital assets etc. 'ence! short run is defined as a period where adjustments to changed conditions are only partial.
57

The short run cost function relates to the short run production function. It implies two sets of input components 8 -a. (i"ed inputs and -b. >ariable inputs. (i"ed inputs are unalterable. They remain unchanged over a period of time. ,n the other hand! variable factors are changed to vary the output in the short run. Thus! in the short period some inputs are fi"ed in amount and a firm can e"pand or contract its output only by changing the amounts of other variable inputs. The cost output relationship in the short run refers to a particular set of conditions where the scale of operation is limited by the fi"ed plant and e uipment. 'ence! the costs of the firm in the short run are divided into fi"ed cost and variable costs. %e shall study these two concepts of costs in some detail 1. Fi$ed costs These costs are incurred on fi"ed factors li#e land, buildings, e%uipments, plants, superior type of labor, top management etc. Fi"ed costs in the short run remain constant because the firm does not change the size of plant and the amount of fi"ed factors employed. Fi$ed costs do not 7ary #it! eit!er e$pansion or contraction in output . These costs are to be incurred by a firm even output is #ero. *ven if the firm close down its operation for some time temporarily in the short run! but remains in business! these costs have to be borne by it. 'ence! these costs are independent of output and are referred to as unavoidable contractual cost. Prof. Darshall called fi"ed costs as supplementary costs. They include such items as contractual rent payment! interest on capital borrowed! insurance premiums! depreciation and maintenance allowances! administrative e"penses like manager1s salary or salary of the permanent staff! property and business ta"es! license fees! etc. They are called as overhead costs because these costs are to be incurred whether there is production or not. These costs are to be distributed on each unit of output produced by a firm. 'ence! they are called as indirect costs. 2. %aria&le costs The cost corresponding to !ariable factors are discussed as !ariable costs. These costs are
58

incurred on ra

materials, ordinary labor, transport, po er, fuel,

ater etc,

hich directly

!ary in the short run. >ariable costs directly and proportionately increase or decrease with the level of output. If a firm shuts down for some time in the short run2 then it will not use the variable factors of production and will not therefore incur any variable costs. >ariable costs are incurred only when some amount of output is produced. Total variable costs increase with increase in the level of production and vice0versa. Prof. Darshall called variable costs as prime costs or direct costs because the volume of output produced by a firm depends directly upon them. It is clear from the above description that production costs consist of both fi"ed as well as variable costs. The difference between the two is meaningful and relevant only in the short run. In the long run all costs become variable because all factors of production become adjustable and variable in the long run. 'owever! the distinction between fi"ed and variable costs is very significant in the short run because it influences the average cost behavior of the firm. In the short run! even if a firm wants to close down its operation but wants to remain in business! it will have to incur fi"ed costs but it must cover at least its variable costs. Cost output relations!ip and nature and &e!a7ior of cost cur7es in t!e s!ort run In order to study the relationship between the level of output and corresponding cost of production! we have to prepare the cost schedule of the firm. & cost schedule is a statement of a !ariation in costs resulting from !ariations in the le!els of output. It sho s the response of cost to changes in output. A hypothetical cost schedule of a firm has been represented in the following table. 1utput in Units C : ; < G B FC <IC <IC <IC <IC <IC <IC (%C 0 :JC ;GC ;KC <:B G;C (C <IC BGC ICC I<C IKB KJC AFC 0 <IC :JC :;C HC K;
59

A%C 0 :JC :;C HC KJ JG

AC 0 BGC <CC ;:C :IJ :BI

MC 0 :JC IC <C GB :CB

<IC

I<C

HCC

IC

:CB

:IB

;:C

,n the basis of the above cost schedule! we can analyse the relationship between changes in the level of output and cost of production. If we represent the relationship between the two in a geometrical manner! we get different types of cost curves in the short run. In the short run! generally we study the following kinds of cost concepts and cost curves. 1. (otal fi$ed cost C(FCB TF2 refers to total money e"penses incurred on fi"ed inputs li#e plant, machinery, tools <e%uipments in the short run. Total fi"ed cost corresponds to the fi"ed inputs in the short run production function. T(& remains the same at all levels of output in the short run. It is the same when output is nil. It indicates that whatever may be the uantity of output! whether : to I units! T(& remain constant. The T(& curve is hori#ontal and parallel to ,9a"is! showing that it is constant regardless of out put per unit of time. T(& starts from a point on La"is indicating that the total fi"ed cost will be incurred even if the output is #ero. In our e"ample! @s <CCCC is T(&. It is obtained by summing up the product or uantities of the fi"ed factors multiplied by their respective unit price. (FC D (C (%C Figure refer !ard copy

2. (otal 7aria&le cost C(%CB T=2 refers to total money e"penses incurred on the !ariable factors inputs li#e ra materials, po er, fuel, ater, transport and communication etc, in the short run. Total variable cost corresponds to variable inputs in the short run production function. It is obtained by summing up the production of uantities of variable inputs multiplied by their prices. The formula to calculate T>& is as follows. T>& 5 T&T(&.
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T>& 5 f -4. i.e. T>& is an increasing function of out put. In other words T>& varies with output. It is nil! if there is no production. Thus! it is a direct cost of output. T>& rises sharply in the beginning! gradually in the middle and sharply at the end in accordance with the law of variable proportion. The law of variable proportion e"plains that in the beginning to obtain a given uantity of output! relative variation in factors needed are in less proportion! but after a point when the diminishing returns operate! variable factors are to be employed in a larger proportion to increase the same level of output. T>& curve slope upwards from left to right. T>& curve rises as output is e"panded. %hen out put is [ero! T>& also will be #ero. 'ence! the T>& curve starts from the origin. (%CD(C-(FC FI@U/) refer !ard copy

3. (otal cost C(CB The total cost refers to the aggregate money e"penditure incurred by a firm to produce a gi!en %uantity of output. The total cost is measured in relation to the production function by multiplying the factor prices with their uantities. T& 5 f -4. which means that the T.&. varies with the output. Theoretically speaking T& includes all kinds of money costs! both e"plicit and implicit cost. /ormal profit is included in the total cost as it is an implicit cost. It includes fi"ed as well as variable costs. 'ence! T& 5 T(& FT>&. T& varies in the same proportion as T>&. In other words! a variation in T& is the result of variation in T>& since T(& is always constant in the short run. FI@U/) refer !ard copy

The total cost curve is rising upwards from left to right. In our e"ample the T& curve starts form @s. <CC0CC because even if there is no output! T(& is a positive amount. T& and T>& have same shape T& 5 T(& F T>& T& because an increase in output increases them
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both by the same amount since T(& is constant. T& curve is derived by adding up vertically the T>& and T(& curves. The vertical distance between T>& curve and T& curve is e ual to T(& and is constant throughout because T(& is constant. -. A7erage fi$ed cost CAFCB &!erage fi"ed cost is the fi"ed cost per unit of output. 6hen TF2 is di!ided by total units of out put &F2 is obtained, Thus, A)& * T)&+Q FI@U/) refer !ard copy

A(& and output have inverse relationship. It is higher at smaller level and lower at the higher levels of output in a given plant. The reason is simple to understand. 3ince A(& 5 T(&E4! it is a pure mathematical result that the numerator remaining unchanged! the increasing denominator causes diminishing product. 'ence! T(& spreads over each unit of out put with the increase in output. &onse uently! A(& diminishes continuously. This relationship between output and fi"ed cost is universal for all types of business concerns. The A(& curve has a negative slope. The curve slopes downwards throughout the length. The A(& curve goes very nearer to 9 a"is! but never touches a"is. Araphically it will fall steeply in the beginning! gently in middle and tend to become parallel to ,9 a"is. Dathematically speaking as output increases! A(& diminishes. =ut A(& will never become #ero because the T(& is a positive amount. A(& will never fall below a minimum amount because in the short run! plant capacity is fi"ed and output cannot be enlarged to an unlimited e"tent. 0. A7erage 7aria&le cost= CA%CB The a!erage !ariable cost is !ariable cost per unit of output. &=2 can be computed by di!iding the T=2 by total units of output. Thus A,& * T,&+Q. The A>& will come down in the beginning and then rise as more units of output are produced with a given plant. This is because as we add more units of variable factors in a fi"ed plant! the efficiency of
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the inputs first increases and then it decreases. The A>& curve is a M shaped cost curve. It has three phases. FI@U/) refer !ard copy

a. 5ecreasing p!ase In the first phase from A to =! A>& declines! As output e"pands! A>& declines because when we add more uantity of variable factors to a given uantity of fi"ed factors! output increases more efficiently and more than proportionately due to the operation of increasing returns. &. Constant p!ase In the II phase! i.e. at =! A>& reaches its minimum point. %hen the proportion of both fi"ed and variable factors are the most ideal! the output will be the optimum. ,nce the firm operates at its normal full capacity! output reaches its #enith and as such A>& will become the minimum. c. Increasing p!ase In the III phase! from = to &! A>& rises when once the normal capacity is crossed! the A>& rises sharply. This is because additional units of variables factors will not result in more than proportionate output. 'ence! greater output may be obtained but at much greater A>&. The old proverb Too many cooks spoil the broth aptly applies to this III stage. It is clear that as long as increasing returns operate! A>& falls and when diminishing returns set in! A>& tends to increase.

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8. A7erage total cost CA(CB or A7erage cost CACB &c refers to cost per unit of output. &2 is also #no n as the unit cost since it is the cost per unit of output produced. A& is the sum of A(& and A>&. Average total cost or average cost is obtained by dividing the total cost by total output produced. A& 5 T&E4 Also A& is the sum of A(& and A>&. In the short run A& curve also tends to be M shaped. The combined influence of A(& and A>& curves will shape the nature of A& curve. FI@U/) refer !ard copy

As we observe! average fi"ed cost begin to fall with an increase in output while average variable costs come down and rise. As long as the falling effect of A(& is much more than the rising effect of A>&! the A& tends to fall. At this stage! increasing returns and economies of scale operate and complete utili#ation of resources force the A& to fall. %hen the firm produces the optimum output! A& becomes minimum. This is called as least 8 cost output level. Again! at the point where the rise in A>& e"actly counter balances the fall in A(&! the balancing effect causes A& to remain constant. In the third stage when the rise in average variable cost is more than drop in A(&! then the A& shows a rise! %hen output is e"panded beyond the optimum level of output! diminishing returns set in and diseconomies of scale starts operating. At this stage! the indivisible factors are used in wrong proportions. Thus! A& starts rising in the third stage. The short run A& curve is also called as 4Plant cur7e6. It indicates the optimum utili#ation of a given plant or optimum plant capacity.

9. Marginal Cost CMCB

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>arginal cost may be defined as the net addition to the total cost as one more unit of output is produced. In other ords, it implies additional cost incurred to produce an additional unit. (or e"ample! if it costs @s. :CC to produce BC units of a commodity and @s. :CB to produce B: units! then D& would be @s. B. It is obtained by calculating the change in total costs as a result of a change in the total output. Also D& is the rate at which total cost changes with output. 'ence! D& 5 ? T& E ? T4. %here ? T& stands for change in total cost and ? T4 stands for change in total output. Also D&n 5 T&n 8T& n: It is necessary to note that D& is independent of T(& and it is directly related to T>& as we calculate the cost of producing only one unit. In the short run! the D& curve also tends to be M shaped. The shape of the D& curve is determined by the laws of returns. If D& is falling! production will be under the conditions of increasing returns and if D& is rising! production will be subject of diminishing returns. FI@U/) refer to !ard copy

(!e ta&le indicates t!e relations!ip &et#een AC E MC 1utput in Units : ; < G B I K J (C in /s. :BC :HC ;;C ;<I ;KC <;G G:B BJC AC in /s. :BC HB K< BH BG BG BH K; 5ifference in /s. MC 0 GC <C :I <G BG H: :IB

FI@U/) refer !ard copy

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/elation &et#een AC and MC (rom the diagram it is clear that) :. =oth D& and A& fall at a certain range of output and rise afterwards. ;. %hen A& falls! D& also falls but at certain range of output D& tends to rise even though A& continues to fall. 'owever! D& would be less than A&. This is because D& is attributed to a single unit where as in case of A&! the decreasing A& is distributed over all the units of output produced. <. 3o long as A& is falling! D& is less than A&. 'ence! D& curve lies below A& curve. It indicates that fall in D& is more than the fall in A&. D& reaches its minimum point before A& reaches its minimum. A&5D& G. %hen A& is rising! after the point of intersection! D& will be greater than A&. This is because in case of D&! the increasing D& is attributed to a single unit! where as in case of A&! the increasing A& is distributed over all the output produced. B. 3o long as the A& is rising! D& is greater and A&. 'ence! A& curve lies to the left side of the D& curve. It indicates that rise in D& is more than the rise in A&. I. D& curve cuts the A& curve at the minimum point of the A& curve. This is because! when D& decreases! it pulls A& down and when D& increases! it pushes A& up. %hen A& is at its minimum! it is neither being pulled down or being pushed up by the D&. Thus! %hen A& is minimum! D& 5 A&. The point of intersection indicates the least cost combination point or the optimum position of the firm. At output 4 the firm is working at its ,ptimum &apacity with lowest A&. =eyond 4! there is scope for Da"imum &apacity with rising cost.

Cost 1utput /elations!ip in t!e .ong /un

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$ong run is defined as a period of time here ad?ustments to changed conditions are complete. It is actually a period during which the uantities of all factors! variable as well as fi"ed factors can be adjusted. 'ence! there are no fi"ed costs in the long run. In the short run! a firm has to carry on its production within the e"isting plant capacity! but in the long run it is not tied up to a particular plant capacity. If demand for the product increases! it can e"pand output by enlarging its plant capacity. It can construct new buildings or hire them! install new machines! employ administrative and other permanent staff. It can make use of the e"isting as well as new staff in the most efficient way and there is lot of scope for making indivisible factors to become divisible factors. ,n the other hand! if demand for the product declines! a firm can cut down its production permanently. The si#e of the plant can also be reduced and other e"penditure can be minimi#ed. 'ence! production cost comes down to a greater e"tent in the long run. As all costs are variable in the long run! the total of these costs is total cost of production. @ence, the distinction bet een fi"ed and !ariables costs in the total cost of production ill disappear in the long run. In the long run only the average total cost is +ong run average cost is the long run total cost divided by the level of output. In brief! it is per unit cost of production of different levels of output by changing the si#e of the plant or scale of production. The long run cost 8 output relationship is e"plained by drawing a long run cost curve through short 8 run curves as the long period is made up of many short 8 periods as the day is made up of ;G hours and a week is made out of K days. This curve e"plains how costs will change when the scale of production is varied. FI@U/) refer !ard copy important and considered in taking long term output decisions.

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The long run cost curves are influenced by the laws of return to scale as against the short run cost curves which are subject to the working of law of variable proportions. In the short run the firm is tied with a given plant and as such the scale of operation remains constant. There will be only one A& curve to represent one fi"ed scale of output in the short run. In the long run as it is possible to alter the scale of production! one can have as many A& curves as there are changes in the scale of operations. In order to derive +A& curve! one has to draw a number of 3A& curves! each curve representing a particular scale of output. The +A& curve will be tangential to the entire family of 3A& cures. It means that it will touch each 3A& curve at its minimum point.

Production cost difference in t!e s!ort run and long run

FI@U/) refer !ard copy

In the diagram! the +A& curve is drawn on the basis of three possible plant si#es. &onse uently! we have three different 3A& curves 8 3A&:! 3A&; and 3A&<. They represent three different scales of output. (or output ,D< the A& will be +;D; in the short run as well as the long run. %hen output is to be e"panded to ,D<! it can be obtained at a higher average cost of production. 6<! D< is the short run A& because! scale of production would remain constant in the short run. =ut the same output of ,D< can be produced at a lower A& of +<D< in the long run since the scale of production can be modified according to the re uirements. The distance between 6<+< represent difference between the cost of production in the short run and long run.
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3imilarly! when output is contracted to ,D: in the short run! 6:D: will become the short run A& and +:D: will be the long run A&. 'ence! 6:+: indicates the differences between short run and long run cost of production. If we join points +:! +; and +< we get +A& curve. I*portant features of long run AC cur7es 1. (angent cur7e ?ifferent 3A& curves represent different operational capacities of different plants in the short run. +A& curve is locus of all these points of tangency. The 3A& curve can never cut a +A& curve though they are tangential to each other. This implies that for any given level of output! no 3A& curve can ever be below the +A& curve. 'ence! 3A& cannot be lower than the +A& in the ling run. Thus! +A& curve is tangential to various 3A& curves. 2. )n7elope cur7e It is known as *nvelope curve because it envelopes a group of 3A& curves appropriate to different levels of output. 3. Flatter U s!aped or dis! s!aped cur7e. The +A& curve is also U s!aped or dis! s!aped cost curve. =ut It is less pronounced and much flatter in nature. +A& gradually falls and rises due to economies and diseconomies of scale. -. Planning cur7e. The +A& cure is described as the Planning Cur7e of the firm because it represents the least cost of producing each possible level of output. This helps in producing optimum level of output at the minimum +A&. This is possible when the entrepreneur is selecting the optimum scale plant. ,ptimum scale plant is that si#e where the minimum point of 3A& is tangent to the minimum point of +A&.

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0. Mini*u* point of .AC cur7e s!ould &e al#ays lo#er t!an t!e *ini*u* point of 'AC cur7e. This is because +A& can never be higher than 3A& or 3A& can never be lower than +A&. The +A& curve will touch the optimum plant 3A& curve at its minimum point. A rational entrepreneur would select the optimum scale plant. ,ptimum scale plant is that si#e at which 3A& is tangent to +A&! such that both the curves have the minimum point of tangency. In the diagram! ,D; is regarded as the optimum scale of output! as it has the least per unit cost. At ,D; output +A& 5 3A&. +A& curve will be tangent to 3A& curves lying to the left of the optimum scale or right side of the optimum scale. =ut at these points of tangency! neither +A& is minimum nor will 3A& be minimum.3A& curves are either rising or falling indicating a higher cost Managerial Use of .AC The study of +A& is of greater importance in managerial decision making process. :. It helps the management in the determination of the best si#e of the plant to be constructed or when a new one is introduced in getting the minimum cost output for a given plant. =ut it is interested in producing a given output at the minimum cost. ;. The +A& curve helps a firm to decide the si#e of the plant to be adopted for producing the given output. (or outputs less than cost lowering combination at the optimum scale i.e.! when the firm is working subject to increasing returns to scale! it is more economical to under use a slightly large plant operating at less than its minimum cost 8 output than to over use smaller unit. &onversely! at output beyond the optimum level! that is when the firm e"perience decreasing return to scale! it is more economical to over use a slightly smaller plant than to under use a slightly larger one. Thus! it e"plains why it is more economical to over use a slightly small plant rather than to under use a large plant.

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<. +A& is used to show how a firm determines the optimum si#e of the plant. An optimum si#e of plant is one that helps in best utili#ation of resources in the most economical manner. FI@U/) refer !ard copy .ong /un Marginal cost

A long run marginal cost curve can be derived from the long run average cost curve. Pust as the 3D& is related to the 3A&! similarly the +D& is related to the +A& and! therefore! we can derive the +D& directly from the +A&. In the diagram we have taken three plant si#es -for the sake of simplicity. and the corresponding three 3A& and 3D& curves. The +A& curve is drawn by enveloping the family of 3A& curves. The points of tangency between the 3A& and the +A& curves indicate different outputs for different plant si#es. If the firm wants to produce ,/ output in the long run! it will have to choose the plant si#e corresponding to 3A&:. The +A& curve is tangent to 3A&: at point A. (or ,/ output! the average cost is /A and the corresponding marginal cost is /= If +A& curve is tangent to 3A&: curve at point A! the corresponding +D& curve will have to be e ual to 3D&: curve at point =. The +D& will pass through point B. In other words! where +A& is e ual to 3A& curve -for a given output. the +D& will have to be e ual to a given 3D&. If output ,4 is to be produced in the long run! it will be done at point c which is the point of tangency between 3A&; and the +A&. At point &! the short 8run average cost -3A&;. and the short run marginal cost -3D&;. are e ual and! therefore! the +A& for output ,4 is 4& and the corresponding +D& is also 4&. The +D& curve will! therefore pass through point &.

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(inally! for output ,@! at point ? the +A& is tangent to 3A&<. (or ,@ output at point * +D& is passing through 3D&<. =y connecting points = !& and *! we can draw the long run marginal cost curve. C1'( 1F P/15UC(I13= F1/MU.A' \ T& 5 cost per unit " total production. ,r T& 5 T(& F T>& \ T(& 5 T& T>& or A(& " 4 T>& 5 T& 8 T(& or A>& " 4 or addition of D& A(& 5 A& 8 A>& or T(&E4 A>& 5 A& 8 A(& or T>&E4 A& 5 A(& F A>& or T&E4 D& 5 T&n T&n: or ? T& E ? T4. 'u**ary The main objective of production is to satisfy the demand for different kinds of goods and services of the community. The term Inputs refers to all those things or items which are re uired by the firm to produce a particular product. Production always results in either creation of new utilities or addition of values. It is an activity that increases consumer satiability of goods and services. Production is undertaken by producers and basically it depends on cost of production. The primary and the ultimate aim of the economic activity is the satisfaction of human wants. In Technical sense production is concerned with conversion of inputs into output. The entire theory of production centre round the concept of production function.
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A production (unction e"presses the technological or engineering relationship between physical uantity of inputs employed and physical uantity of outputs obtained by a firm. Production function can be represented in the form of a mathematical model or e uation as 4 5 f Production of goods re uires resources or inputs. The analysis of production function is generally carried with reference to time period which is called short period and long period. (i"ed inputs are those factors the uantity of which remains constant. >ariable inputs are those factors the uantity of which varies with variations in the levels of output produced by a firm The short run is a period of time in which only one input -say labor. is allowed to vary while other inputs land and capital are held fi"ed. Though production function may appear as highly abstract and unrealistic! in reality! it is both logical and useful. Production function also helps in making long run decisions. The technological physical relationship between inputs and outputs per unit of time! is referred to as production function.

The production function is the name given to the relationship between rates of input of productive services and the rate of output of the product. A variable input is one whose uantity can be changed readily when market condition suggests that an immediate change in output is beneficial to the producer. +ong run refers to that period of time in which all inputs are variable. In this case as the uantity of variable inputs is increased to a given uantity of fi"ed factors! output increases less than proportionately. Total output diminishes because there is a limit to the full utili#ation of indivisible factors and introduction of speciali#ation. The law gives guidance that by making continuous improvements in science and technology! the producer can postpone the occurrence of diminishing returns.

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The marginal rate of technical substitution of labour for capital is that uantity of capital which has to be reduced on an increase in the use of labour by one unit to keep the level of production constant.

In the short run! as the amount of variable factors increases! other things remaining e ual! output -or the returns to the factors varied. will increase more than proportionately to the amount of variable inputs in the beginning! then it may increase in the same proportion and ultimately it will increase less proportionately.

In economics! returns to scale and economies of scale are related terms that describe what happens as the scale of production increases in the long run. An economic concept referring to a situation in which economies of scale no longer function for a firm. /etwork e"ternalities resemble economies of scale! but they are not considered such because they are a function of the number of users of a good or service in an industry! not of the production efficiency within a business.

The study of economies of scale is associated with large scale production. Internal *conomies are those economies which arise because of the actions of an individual firm to economi#e its cost *"ternal economies are those economies which accrue to the firms as a result of the

e"pansion in the output of whole industry. In economics! an iso uant -derived from uantity and the Areek word iso! meaning e ual. is a contour line drawn through the set of points at which the same uantity of output is produced while changing the uantities of two or more inputs. Iso uants are typically drawn on capital0labor graphs! showing the technological tradeoff between capital and labor in the production function! and the decreasing marginal returns of both inputs. &ost concept refers total money e"penses incurred to produce a particular uantity of output by the producer. &ost and output are correlated. &ost output relations play an important role in almost all business decisions.
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Darginal cost may be defined as the net addition to the total cost as one more unit of output is produced. In other words! it implies additional cost incurred to produce an additional unit.

+ong run is defined as a period of time where adjustments to changed conditions are complete. +ong run average cost is the long run total cost divided by the level of output.

;ey#ords
Production &ommunity Technology Transport &ommunication %arehousing Darketing =anking 3hipping Insurance Inde" *mployment Prosperity ?ependence Technologically @eferred Proportion ?iminishing Immense ?etermined
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Technical *ngineering /on0proportional ,utput 'ypothetical ?iminish Proportionately *"istence /on0e"istence ?ecreasing Interchangeably 4uantities ?iseconomies ,ptimi#ation Iso uant &onve" *lasticity

/e7ie# <uestions
:. ?efine production.

;. %hat is production function] <. %ho are the agents of production] G. *"plain returns to scale.
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B. *"plain short0term and long0term production function. I. %hat is economics of scale]

K. ?escribe internal and e"ternal economics. J. *"plain the benefits and importance of production optimi#ation. H. *"plain the managerial uses of production function. :C. %hat is cost concept] ::. %hat are the different kinds of cost concept] :;. %hat are the determinants of cost] :<. *"plain short run and long run cost curves. :G. ?escribe cost output decision. :B. 'ow to estimate cost] :I. %hat is iso uants] :K. *"plain the types of iso uants.

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