Theory of Production and Costs
Theory of Production and Costs examines how inputs become output and how costs behave in the short and long run. BIEAP tests the production function, the law of variable proportions, returns to scale, isoquants, and cost curves.
Core rules
- A production function shows the maximum output from given inputs. Short run has at least one fixed input; long run all inputs are variable.
- The law of variable proportions: as more variable input is added to fixed inputs, marginal product first rises, then falls, and may become negative.
- Total product, average product and marginal product are linked: MP cuts AP at AP’s maximum.
- Returns to scale describe output response when all inputs change proportionally: increasing, constant or decreasing.
- In the short run, total cost = total fixed cost + total variable cost. Average fixed cost continually falls; average variable cost is U-shaped.
- Marginal cost cuts average cost at its minimum. MC reflects the cost of one more unit.
Worked example
A firm’s total cost rises from ₹500 to ₹560 when output rises from 10 to 12 units. MC = ΔTC/ΔQ = 60/2 = ₹30. If average cost at 12 units is ₹46.67, MC below AC pulls AC down; MC above AC would push AC up.
Traps
Diminishing marginal returns is not negative marginal product; negative MP means total product falls. Do not treat fixed costs as avoidable in the short run. MC cuts AC at minimum AC, not at maximum AC. Returns to scale is a long-run concept; the law of variable proportions is short-run.