Chapter 1

BASIC PRINCIPALS OF ECONOMICS

ECONOMIES OF PRODUCTION: Production Function: Defined by the maximum output that can be produced with a given input combination Technology is most important aspect Accuracy of production function depends on its use Graph of output as a function of input introduces 3 stages of production i.e. 1. MP > AP > 0; stage 1 production function 2. AP > MP > 0; stage 2 production function 3. MP < 0; stage 3 production function If y = output and x = input, then production function is y = f(x); marginal productivity, MP is fx = f / x and average product is y / x. Stage 2 is economic production, where returns are maximum and cost is minimum. Number of mathematical
1

specifications

for

production function are available.

Compiled by Prof. Prasad Parulekar

e.g. Cobb Douglas production function y = A*x, , with 0 < < 1, express situations at economic regions. Economies of Production refers to economies of scale i.e. advantages enjoyed by firm due to expansion in its sixe or production. Short time period factors of production are fixed, production cant be altered Long time period factors of production varies, size of firm can expand or contract; economy of scale can be enjoyed Due to expansion of production increased But there is limit to expansion or expansion may turn in diseconomies. 1. Up to certain limit, expansion of firm enjoys increase in returns 2. beyond desirable limit, expansion leads to diseconomies, decreases returns returns are

Compiled by Prof. Prasad Parulekar

3. between economies and diseconomies, returns are constant Classification of economies of production (Scale): (A)Internal Economies: advantages enjoyed by individual firms due to its expansion e.g. Hotel industry increase in size of individual restaurant, increases its returns different categories under this type are: 1. Technical economies: (i) economies of advanced technology capital equipments---by small firms (ii) economies of specialization division of labor, (iii) appointing experts for specific functions economies of by-products --- making byproducts from waste reduce production cost, increase output--- enjoyed by large firms, not

Compiled by Prof. Prasad Parulekar

(iv)

economies of linked process --- linked processes under single control, avoids dependence and inconvenience

(v)

economies of dimensions---- large sized equipments economies (administrative

2. Managerial

economies): small firms--- owner has to look after different functions; large firms--- experts, qualified persons can be appointed for different functions 3. Marketing economies: emerges from bulk buying-- large firms---bulk purchase of raw materials---results in regular production, supply at cheap rate; advantages through advertising; concession in transportation charges 4. Financial economies: large firms--- easiliy raises funds, get loans, sell shares, get credits from banks 5. Risk bearing economies (survival economies): large firms---easily face risks arising from economic depression, fall in demand---through product diversification, market diversification etc.
4 Compiled by Prof. Prasad Parulekar

Thus due to increased size (production)---- more than proportionate returns--- diminish production cost--- but up to certain limit (B) External Economies: advantages enjoyed by all firms in industry; growth of particular industry in specific area e.g. Hotel industry--- increases at tourist or famous place--emerges due to localization of industries different types under this economy re--1. Economies of concentration: concentration of particular industry at specific place results in--(i) (ii) (iii) (iv) Provision of efficient transport system Availability of skilled and trained labors Better and cheap credit facilities through development of banks Supply of adequate sources of power of disintegration: growth of Reduces production coat and maximize returns 2. Economies particular industry----other utility firms come up (supplies raw material); other firms use waste to produce by-products; cost of main industry reduces
5 Compiled by Prof. Prasad Parulekar

3. Economies of information: publishing journals by industry--- provides technical information to other firms---- establishing own research center by main industry Diseconomies of Scale: (A) Internal diseconomies: 1. Managerial diseconomies: growth of firm beyond limit-----creates managerial problem; difficult to control; creates co-ordination and supervision problems; decision makers--- do not directly relates to production activity; persons taking decisions and executing them differs; important and responsible functions have to be delegated to lower level officials (inexperienced persons)--- reduces productivity; loosens personal contact between management and labors--creates labor problems---- decreases production efficiency and reduces returns

Compiled by Prof. Prasad Parulekar

2. 2.Technical diseconomies: division of labor and specialization beyond certain limit proves inefficient; equipments working beyond maximum capacity, results inefficient (B) External diseconomies: results due to

concentration of industry beyond limit; results in 1. Transport bottleneck (traffic jam)--- delays raw material supplyreduces production---delays marketing of finished products 2. localization--- increases local rent 3. increased demand for labors---- increases wage rates 4. increase cost of raw material, finance, power etc ---production cost increases

Compiled by Prof. Prasad Parulekar

Compiled by Prof. Prasad Parulekar