Managerial Economics

Q1. Describe Cost-Output Relationship in brief. Answer: Cost-Output Relationship: Cost Function Cost and output are correlated. Cost output relations play an important role in almost all business decisions. It throws light on cost minimization or profit maximization and optimization of output. The relation between the cost and output is technically described as the COST FUNCTION. The significance of cost-output relationship is so great that in economic analysis the cost function usually refers to the relationship between cost and rate of output alone and we assume that all other independent variables are kept constant. Mathematically speaking TC = f (Q) where TC = Total cost and Q stands for output produced. Cost function depends on three important variables. 1. Production function: If a firm is able to produce higher output with a little quantity of inputs, in that case, the cost function becomes cheaper and vice-versa. 2. The market prices of inputs: If market prices of different factor inputs are high in that case, cost function becomes higher and vice-versa. 3. Period of time: Cost function becomes cheaper in the long run and it would be relatively costlier in the short run. Types of cost function 1. Cost-Output Relationship and Cost Curves in the Short-Run: It is interesting to note that the relationship between the cost and output is different at two different periods of time i.e. short-run and long run. Generally speaking, cost of production will be relatively higher in the short run when compared to the long run. This is because a producer will get enough time to make all kinds of adjustments in the productive process in the long run than in the short run. When cost and output relationship is represented with the help of diagrams, we get short run and long run cost curves of the firm. Now we shall make a detailed study of cost output relations both in the short-run as well as in the long run. Short-run is a period of time in which only the variable factors can be varied while fixed factors like plant, machinery etc. remains constant. The short run cost function relates to the short run production function. It implies two sets of input components (a) fixed inputs and (b) variable inputs. Fixed inputs are unalterable. They remain unchanged over a period of time. On the other hand, variable factors are changed to vary the output in the short run. Thus, in the short period some inputs are fixed in amount and a firm can expand or contract its output only by changing the amounts of other variable inputs. The cost-output relationship in the short run refers to a particular set of conditions where the scale of operation is limited by the fixed plant and equipment. Hence, the costs of the firm in the short run are divided into fixed cost and variable costs.

2. Cost Output Relationship in the Long Run: Long run is defined as a period of time where adjustments to changed conditions are complete. It is actually a period during which the quantities of all factors, variable as well as fixed factors can be adjusted. Hence, there are no fixed costs in the long run. In the short run, a firm has to carry on its production within the existing plant capacity, but in the long run it is not tied up to a particular plant capacity. If demand for the product increases, it can expand output by enlarging its plant capacity. It can construct new buildings or hire them, install new machines, employ administrative and other permanent staff. It can make use of the existing as well as new staff in the most efficient way and there is lot of scope for making indivisible factors to become divisible factors. On the other hand, if demand for the product declines, a firm can cut down its production permanently. The size of the plant can also be reduced and other expenditure can be minimized. Hence, production cost comes down to a greater extent in the long run. As all costs are variable in the long run, the total of these costs is total cost of production. Hence, the distinction between fixed and variables costs in the total cost of production will disappear in the long run. In the long run only the average total cost is important and considered in taking long term output decisions. Q2. Define Supply. Explain the Determinants of Supply. Answer: According to Thomas, The supply of goods is the quantity offered for sale in a given market at a given time at various prices. According to Prof. Macconnel supply may be defined as a schedule which shows the various amounts of a product which a producer is willing to and able to produce and make available for sale in the market at each specific price in a set of possible prices during some given period. Determinants of Supply Apart from price, many factors bring about changes in supply. Among them the important factors are: 1. Natural factors: Favorable natural factors like good climatic conditions, timely, adequate, well distributed rainfall results in higher production and expansion in supply. On the other hand, adverse factors like bad weather conditions, earthquakes, droughts, untimely, ill-distributed, inadequate rainfall, pests etc., may cause decline in production and contraction in supply. 2. Change in techniques of production: An improvement in techniques of production and use of modern, highly sophisticated machines and equipments will go a long way in raising the output and expansion in supply. On the contrary, primitive techniques are responsible for lower output and hence lower supply. 3. Cost of production: Given the market price of a product, if the cost of production rises due to higher wages, interest and price of inputs, supply decreases. If the cost of production falls, on account of lower wages, interest and price of inputs, supply rises. 4. Prices of related goods: If prices of related goods fall, the seller of a given commodity offer more units in the market even though, the price of his product has not gone up. Opposite will be the case when the price of related goods rises.

5. Government policy: When the government follows a positive policy, it encourages production in the private sector. Consequently, supply expands. On the other hand, output and supply cripples when the government adopts a negative policy. 6. Monopoly power: Supply tends to be low, when the market is controlled by monopolists, or a few sellers as in the case of oligopoly. Generally supply would be more under competitive conditions. 7. Number of sellers or firms: Supply would be more when there are a large number of sellers. Similarly production and supply tends to be more when production is organized on large scale basis. If rate or speed of production is high, supply expands. Opposite will be the case when number of sellers is less, small scale production and low rate of production. 8. Complementary goods: In case of joint demand, the production & sale of one product may lead to production and sale of other product also. 9. Discovery of new source of inputs: Discovery of new sources of inputs helps the producers to supply more at the same price & vice versa. 10. Improvements in transport and communication: This will facilitate free and quick movements of goods and services from production centers to marketing centers. 11. Future rise in prices: When sellers anticipate a further rise in price, in that case current supply tends to fall. Opposite will be the case when, the seller expect a fall in price.