Producer Behaviour and Supply
Producer Behaviour and Supply tests the law of variable proportions, cost and revenue relationships, and the law of supply with elasticity.
Core rules
- Short run: at least one factor fixed. Long run: all factors variable.
- Law of variable proportions: Stage I, TP rises at an increasing rate and MP rises; Stage II, TP rises at a diminishing rate and MP falls but stays positive; Stage III, TP falls and MP is negative. A rational producer operates in Stage II.
- TP-MP-AP: MP is the slope of TP; AP = TP/L; MP cuts AP at AP's maximum.
- Cost: TC = TFC + TVC; AC = TC/Q; AVC = TVC/Q; AFC = TFC/Q; MC = change in TC divided by change in Q. MC is U-shaped and unaffected by fixed cost.
- Revenue: TR = P × Q; MR = change in TR divided by change in Q. Under perfect competition MR = AR = P.
- Law of supply: positive price-quantity relation. Es = % change in quantity ÷ % change in price; a straight-line supply curve through the origin has Es = 1.
Worked example
At Q = 3, TC = ₹120; at Q = 4, TC = ₹150; TFC stays ₹30. MC of the fourth unit = 30/1 = ₹30. TVC at Q = 4 is 150 − 30 = ₹120, so AVC = ₹30. AC = 150/4 = ₹37.50 and AFC = 30/4 = ₹7.50, so indeed AC = AVC + AFC.
Traps that cost marks
- Saying MC can fall because fixed cost falls; MC ignores fixed cost entirely.
- Marking Stage III as rational because TP is only slightly falling; MP is negative there.
- Confusing an increase in supply (rightward shift) with an increase in quantity supplied (movement along the curve).