Production and Cost
The Production and Cost domain tests input-output relations, the law of variable proportions, returns to scale and short-run cost curves. Expect questions linking total, average and marginal product with total, average and marginal cost.
Core rules and concepts
- A production function shows the maximum output obtainable from given inputs.
- In the short run, at least one factor is fixed; in the long run, all factors are variable.
- Law of variable proportions: with one variable factor, marginal product first rises, then falls, and can become negative.
- Returns to scale describe output response when all inputs change proportionately.
- Fixed costs do not vary with output; variable costs do. TC = TFC + TVC; AC = TC/Q; MC = ΔTC/ΔQ.
- MC cuts AC at AC’s minimum. MP cuts AP at maximum AP.
Worked example
A firm’s TFC is ₹100. TVC at 1 unit is ₹60 and at 2 units is ₹100. TC is ₹160 and ₹200. MC of the second unit = (200−160)/(2−1) = ₹40. AC at 2 units = 200/2 = ₹100. Since MC (₹40) is below AC (₹100), AC is falling. Compare marginal with average, not just totals.
Traps that cost marks
Do not treat factory rent as variable in the short run. Do not say MC cuts AC at maximum AC; it cuts at minimum AC. Do not confuse diminishing marginal product with decreasing returns to scale. Negative marginal product means total product is falling.