Producer Behaviour and Supply
Here the exam tests production with fixed and variable factors, the shape of short-run cost curves, and the link from cost to the firm's supply curve. Numerical questions on TP/MP/AP and on cost schedules are common.
Core rules
- Production function Q = f(L, K). In the short run capital is fixed; the law of variable proportions operates.
- Relationship: when MP > AP, AP rises; MP = AP at maximum AP; when MP < AP, AP falls; TP is maximum when MP = 0; MP becomes negative thereafter.
- Three stages: increasing returns (up to maximum AP), diminishing returns (maximum AP to MP = 0), negative returns. A rational producer operates in stage 2.
- TFC is constant at all output levels; TVC rises from the origin; TC = TFC + TVC. AC = AFC + AVC. MC cuts both AVC and AC at their minimum points.
- Revenue: TR = P × Q, AR = TR/Q, MR = ΔTR/ΔQ. Under perfect competition AR = MR; under monopoly and monopolistic competition MR < AR.
- Law of supply: other things equal, quantity supplied rises with price. Elasticity of supply Es = %ΔQ/%ΔP; a vertical curve is perfectly inelastic, horizontal perfectly elastic.
Worked example
At 5 units, TFC = ₹100 and TVC = ₹150, so TC = ₹250, AC = ₹50, AVC = ₹30, AFC = ₹20. The 6th unit adds ₹40 to cost, so MC = ₹40, TC = ₹290 and AC = ₹48.33. Because MC (₹40) is below AC (₹50), average cost falls - the standard MC–AC relationship.
Traps that cost marks
- Saying TP is maximum where MP = AP; it is maximum where MP = 0.
- Treating MC as the same as AVC or as a fixed cost.
- Drawing the firm's supply curve as the whole MC curve rather than the part above minimum AVC.
- Mixing up movement along a supply curve (own price) with a shift (technology, input prices, taxes).