UNIT-III BEFA Notes.
UNIT-III BEFA Notes.
UNIT-III BEFA Notes.
Production is a process in which economic resources or inputs (natural resources like land,
labour and capital equipments) are combined by entrepreneurs to create economic goods and
services (also referred to as outputs or products).
Let us consider an example of short run production function with one variable input labour(L).
Production Function with two variable inputs:-
Production process that requires two inputs, capital(C) and labour(L) to produce a given
output (Q). There could be more than two inputs in a real life situation.
The production function based on two inputs can be expressed as ;
Q = f(C, L)
Where:
f = function of
C = Capital,
L = Labour.
Production Functions with Two Variable Factors: Isoquants.
For the analysis of production function with two variable factors we make use of the concept
called Isoquants. We explain the production function with two variable factors and returns to
scale, we shall explain the concept of isoquants (that is, equal product curves) and their
properties.
Isoquants:-
The term Isoquants is derived from the words ‘Iso’ and ‘quant’. ‘Iso’ means equal and
‘quent’ means quantity. Isoquant therefore, means equal quantity. Isoquant curves show
various combinations of two input variable factors such as Capital and Labour. Therefore, an
Isoquant represents a constant quantity of output.
As an isoquant curve represents all such combinations which yield equal quantity of output,
any or every combination is a good combination for the manufacturer. Since he prefers all
these combinations equally, an isoquant curve is also called product indifferent curve.
An Isoquant may be explained with the help of an arithmetical example ;
Returns to Scale:-
The law of returns to scale describes the relationship between variable inputs and output when
all the inputs or factors are used. The law of returns to scale analysis the effects of scale on the
levels of output.
There are three possible types of laws of Returns to scale:
(1) Law of Increasing Returns to Scale
(2) Law of Constant Returns to Scale
(3) Law of Decreasing Returns to Scale
(1) Law of Increasing Returns to Scale:
If the output of a firm increases more than in proportion to an equal percentage increase in all
inputs, the production is said to exhibit increasing returns to scale.
(2) Law of Constant Returns to Scale:
When all inputs are increased by a certain percentage, the output increases by the same
percentage, the production function is said to exhibit constant returns to scale.
(3) Law of Decreasing Returns to Scale:
The term 'diminishing' returns to scale refers to scale where output increases in a smaller
proportion than the increase in all inputs.
Internal and External Economies of Scale:
Economies of scale are of two types :
1. Internal Economies of Scale
2. External Economies of Scale
Internal Economies of Scale:-
Internal Economies refer to the economies introduction costs which accrue to the firm alone
when it expands its output. The following are the sources of Internal Economies of Scale ;
Managerial Economics
Commercial Economics
Financial Economics
Technical Economies
Marketing Economies
Risk Bearing Economies
Economics of Larger Advertising
Cost Analysis: Types of Costs, Short run and Long run Cost Functions.
The institute of cost and management accountants (ICMA) has defined cost as “the amount
expenditure of product cost”. It refers to the study of product cost in relation to price of factors
of production. Every company management is reduced minimum production cost and
maximum profits.
Profit = Total revenue – Total cost.
2). Total Costs (TC), Average Costs (AC), Marginal Costs (MC)
Total Costs (TC) = Fixed + Variable Costs
3). Short-run cost and Long-run cost.
4). Opportunity cost and Actual cost.
5). Explicit cost and Implicit cost.
6). Sunk cost and Incremental cost.
7). Direct cost and Indirect cost.
8). Historical cost and Replacement cost.
9). Accounting cost and Economic cost.
10). Private cost and Social cost.
Cost Function:-
The cost function is defining the relationship between cost and its determinants such as the
size of plant (factory or company), level of output, input prices, technology, efficiency of
management etc..
Cost Function can be expressed as mathematically as follows ;
C = f (S, O, P, T, E)
Where ;
C = Cost
F = function of
S = Size of Plant
O = Output level
P = Price of inputs
T = Technology
E = Efficiency of Management.
The cost function is the relationship between input and output. The cost output functions can
be classified into two types;
(1). Short-run Cost Function
(2). Long-run Cost Function
Fig: Short-run total costs curves Fig: Short-run average & marginal costs curves
From the above graphical representations we observed that average fixed cost continuously
falls over the whole range of output. Since ATC = AFC + AVC, the vertical distance
be-tween average total cost and average variable cost measures average fixed cost. Since AFC
declines over the entire range of output. AVC becomes closer and closer to ATC as output
increases.
(2). Long-run Cost Function:-
In the long run, all the factors (inputs) of production used by an organization. The existing size
of the plant or building can be increased in case of long run. There are no fixed inputs or costs
in the long run. Long run is a period in which all the costs change as all the factors of
production are variable.
Long-Run Cost is represented 3 types of Curves ;
i) Long run Total Cost (LTC)
ii) Long run Average Cost (LAC)
iii) Long run Marginal Cost (LMC)
The following figure represented various Long-run cost curves based on LTC, LAC, and
LMC.
Fig: Long-run total costs curves Fig: Long-run average & marginal costs curves
Therefore, LTC ≤ STC curves.
From the above graphs point A, B, and C, respectively; then they would intersect SMC curves
at P, Q, and R respectively. By joining P, Q, and R, the LMC curve would be drawn.
Market Structures: Nature of Competition, Features of Perfect competition,
Monopoly, Oligopoly, and Monopolistic Competition.
Market is a place where buyer and seller meet, goods and services are offered for the sale and
transfer of ownership occurs. A market may be also defined as the demand made by a certain
group of potential buyers for a goods or service.
Market Structure is a set of market characteristics that determine the nature of market. Market
Structure refers to the large no of activities and distribution of buyers and sellers in the market
for a goods or services.
Nature of Competition:-
Market Structure deals with the selected no of characteristics through buyers and sellers.
Market Structure different conditions in their own situations, different Market Structures
affects the behavior of buyers and sellers.
Market Structures:-
Market structure describes the competitive environment in the market buyers and sellers for
any good or service.
Types of Market Structures: Perfect competition, Monopoly, Oligopoly, and Monopolistic Competition.
Perfect competition:-
Definition:- Perfect competition is a market with a very large number of buyers and sellers.
The market with perfect competition conditions is known as perfect market. The good market
conditions are favorable to promote business. The good market nature is called Perfect
competition.
Monopoly:-
The word monopoly is made up of two syllables, Mono and poly. ‘Mono’ means single and
‘poly’ means seller.
The Monopoly means a single firm will control the entire market. Monopoly is a form of
market organization in which there is only one seller of the products. There are no close
substitutes for the products sold by the seller.
According to Watson, “Monopoly is the only one producer controls of products in the entire
market that has no close substitutes for the products”.
Features of Monopoly:-
The following are the main features / characteristics of Monopoly;
1) Single Seller
2) No close substitutes
3) No entry
4) Large number of Buyers
5) Price level
6) Legal rights and patent rights.
Oligopoly:-
Oligopoly is derived from Greek words ‘Oligos’ and ‘poly’.
‘Oligos’ means a few and ‘poly’ means seller.
Monopolistic Competition:-
The market structure in which a large number of firms selling few differentiate products is
called Monopolistic Competition. It is a market situation there are a large number of buyers
and sellers selling closely related.
Example: There are many toothpaste available in the market, these are closely related goods,
but different size, quality, color, taste etc.
2) Product Differentiation
5) Selling costs
6) Imperfect Knowledge
Types of Pricing:-
The following are the different types of pricing ;
1. Cost – Based Pricing
2. Competition – Oriented Pricing
3. Demand – Oriented Pricing
4. Strategy – Based Pricing
The different stages of Product Life Cycle (PLC) based Pricing contains four stages:
1) Introduction
2) Growth
3) Maturity
4) Decline
The following diagram represents the PLC stages with the life of a product in the markets;
1) Introduction Stage: - It refers to the initial stage where an organization creates awareness
to the customers for the new product. The sales of the organization during this period are
constant. It is also called as Product development stage.
2) Growth Stage:- The growth stage is typically characterized by a strong growth in sales
and profits, and because the company can start to benefit from economies of scale in
production, the profit margins, as well as the overall amount of profit, will increase. This
makes it possible for businesses to invest more money in the promotional activity to maximize
the potential of this growth stage.
3) Maturity Stage: - During the maturity stage, the product is established and the aim for the
manufacturer is now to maintain the market share they have built up. This is probably the most
competitive time for most products and businesses need to invest wisely in any marketing they
undertake. They also need to consider any product modifications or improvements to the
production process which might give them a competitive advantage.
4) Decline Stage: - Eventually, the market for a product will start to shrink, and this is what’s
known as the decline stage. This shrinkage could be due to the market becoming saturated (i.e.
all the customers who will buy the product have already purchased it), or because the
consumers are switching to a different type of product.
Here, Break Even Point: TR=TC Loss Area: TR<TC Profit Area: TR>TC
Significance of BEA:-
To ascertain the profit on a particular level of sales volume or a given capacity of production.
To calculate sales required to earn a particular desired level of profit.
To compare the product lines, sales area, and methods of sales for individual company
To compare the efficiency of the different firms.
To decide whether to add a particular product to the existing product line or drop one from it.
To decide to “make or buy” a given component or spare part.
To decide what promotion mix will yield optimum sales.
Limitations of BEA:-
Break – even - point is based on fixed cost, variable cost and total revenue.
The BEA or BEP can be calculated by the following two formulas based on problem
calculation ;
1. BEA in Units.
BEA = FC / Contribution (C)
2. BEA in Sales.
BEA = [FC / Contribution (C)] x sales
Here,
Contribution = Sales – Variable cost
Contribution = Fixed Cost + Profit.
Angle of incidence: This is the angle between sales line and total cost line at the Break-even
point. It indicates the profit earning capacity of the concern. Large angle of incidence indicates
a high rate of profit a small angle indicates a low rate of earnings.
11. Describe the BEP with the help of a diagram and its uses in business decision making
12. What cost concepts are mainly used for management decision making? Illustrate.
15. A Company reported the following results for two period Sales Profit I Rs. 20,00,000 Rs. 2,00,000
II Rs. 25,00,000 Rs. 3,00,000 Ascertain the BEP, PV ratio, fixes cost and Margin of Safety.
16. If sales in 10000 units and selling price Rs. 20/- per unit. Variable cost is Rs. 10/- per unit and
fixed cost is Rs. 80000. Find out BEP in Units and sales revenue what is profit earned? What should
17. Sales are 1, 10,000 producing a profit of Rs. 4000/- in period I, sales are 150000 producing a profit
of Rs. 12000/- in period II. Determine BEP & fixed expenses.
Objective Questions
1. Conversion of inputs in to output is called as _________________ ( )
3. When a firm expands its Size of production by increasing all factors, It secures certain advantages,
known as ( )
(a) Optimum Size (b) Diseconomies of Scale (c) Economies of Scale (d) None
4. When producer secures maximum output with the least cost combination of factors of production, it
is known as_______ ( )
(a) Consumer’s Equilibrium (b) Price Equilibrium (c) Producer’s Equilibrium (d) Firm’s Equilibrium
(a) Law of fixed proportions (b) Law of returns to scale (c) Law of variable proportions (d) None
6. _________ Is a ‘group of firms producing the same are slightly Different products for the same
7. When proportionate increase in all inputs results in an equal Proportionate increase in output, then
we call____________. ( )
(a) Increasing Returns to Scale (b) Decreasing Returns to Scale (c) Constant Returns to Scale (d) None
8. When different combinations of inputs yield the same level of output Known as ___________. ( )
(a) Different Quants (b) Output differentiation (c) Isoquants (d) Production differentiation
9. When Proportionate increase in all inputs results in more than equal Proportionate increase in
(a) Decreasing Returns to Scale (b) Constant Returns to Scale (c) Increasing Returns to Scale (d) None
10. When Proportionate increase in all inputs results in less than Equal Proportionate increase in
(a) Increasing Returns to Scale (b) Constant Returns to Scale (c) Decreasing Returns to Scale (d) None
11. A curve showing equal amount of outlay with varying Proportions of Two inputs are called
________________. ( )
(a) Total Cost Curve (b) Variable Cost Curve (c) Isocost Curve (d) Marginal Cost Curve
(a) Outlay cost (b) Past cost (c) Opportunity cost (d) Future cost
13. If we add up total fixed cost (TFC) and total variable cost (TVC), we get__ ( )
(a) Average cost (b) Marginal cost (c) Total cost (d) Future cost
15. _______ costs are the costs, which are varies with the level of output. ( )
(a) Place and time (b) Production and sales (c) Demand and supply (d) Cost and income
(a) High price (b) Low price (c) Equilibrium price (d) Marginal price
18. _________is a form of market organization in which there is only one seller of the commodity. ( )
19. The firm is said to be in equilibrium, when it’s Marginal Cost (MC) Equals to___ . ( )
(a) Total cost (b) Total revenue (c) Marginal Revenue (d) Average Revenue
20. Charging very high price in the beginning and reducing it gradually is called ( )
(a) Differential pricing (b) Sealed bid pricing (c) Skimming pricing (d) Penetration pricing