Brief notes on Production, Revenue and Costs

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Production means creation of utility having exchange value. Production function implies technical relationship between inputs and output. In the case of short run production function some inputs are kept constant and one input varies. This forms the subject matter of the law of variable proportions.

In the case of long run production function, all the inputs are variable. This production function is explained by the law of returns to scale.

According to the law of variable proportions, variation in the proportion of the factors used produces different results regarding the output produced. Normally as production is expanded the return first increase, the diminishes and then becomes negative.

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The first stage is the stage of the increasing returns, the second stage is the stage of diminishing returns and the third stage is the stage of negative returns. In agriculture, the stage of increasing returns is comparatively shorter whereas in industry it is much longer. Increasing returns are due to indivisibility of factors, division of labor, internal and external economies. Diminishing returns are due to the overutilization of the factors and imperfect elasticity of substitution between factors. The law of diminishing returns is a logical necessity. The law is universal. The law of increasing returns is an empirical fact.

In the case of the law of returns to scale all the inputs are changed in the same proportions in the long run. The effect on output may take three forms or stage like increasing, constant and diminishing returns to scale. If the increase in output is more than proportional to the increase in inputs, it is a case of increasing returns to scale, if it is ‘proportional, it is a case of constant returns to scale and if it is less than proportional it is a case of diminishing returns to scale. Increasing returns to scale are due to internal economies and external economies. Constant returns to scale are due to the equality between internal and external economies and dis-economies. Diminishing returns to scale are due to internal dis-economies and external dis-economies.

Revenue and Costs:

Revenue has three forms. Total revenue (TR) = QXP or QXAR = Sum total of marginal revenue (MR) TR equals price multiplied by the quantity sold. Average revenue (AR) = TR/Q = Revenue per unit of output Marginal Revenue (MR) = TRn – TRn-1 TR, AR and MR are interrelated.

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Different Concepts of Costs:

Accounting costs are those costs, which are paid by the entrepreneur while hiring the factors of production from outside. These costs are known as explicit costs too. Economic costs include both explicit and implicit costs.

Money costs refer to the total amount of money spent on the production of goods. Real cost of production refers to the trouble, discomfort, pain, displeasure etc. which the factor owners experience at the time of supplying them to producers. The quantitative measurement of real cost is almost impossible. Fixed cost does not change with exchange in output but variable cost change with change in output.

Total cost (TC) = Total fixed cost (TFC) + Total variable cost (TVC).

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In the market, period and short period fixed cost does not change. In the long period all costs are variable. TC curve is the vertical summation of TFCX curve and TVC curve. TC curve moves upward from left to right. Both AC Curve and MC curve are ‘U’ shaped.

Opportunity cost is the alternative cost or transfer cost or transfer earning or displacements cost. It is based upon scarcity and choice. Costs borne by an individual in producing a good are called private costs. Social costs are borne by the society at large. These are non-market costs. For example, smokes from the chimneys of the factories pollute the atmosphere of the locality. This increases the washing bills and medical bills of the community. There is a great divergence between private cost and social cost. When social costs are more than private costs, external dis-economies arise.

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