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Production and Costs – Class 12 Economics notes, important questions and MCQs

NCERT Class 12 Economics, chapter 3. Notes, key terms, important questions with answers and MCQs.

Chapter overview

A production function shows the relationship between inputs and the maximum output that can be produced. In the short run some inputs are fixed, so output changes only by changing variable inputs, and the law of variable proportions applies. In the long run all inputs can vary, giving returns to scale. Costs of production follow from these relationships: fixed and variable costs, and average and marginal costs.

Production function and returns

Short run: at least one input is fixed; long run: all inputs are variable.
Total product (TP), average product (AP = TP ÷ L) and marginal product (MP = change in TP ÷ change in L).
Law of variable proportions: as more units of a variable input are added to a fixed input, MP first rises, then falls, and may become negative; TP is maximum when MP is zero.
Returns to scale: increasing (output rises more than proportionately), constant (proportionately) and decreasing (less than proportionately).

Short-run costs

Total cost (TC) = total fixed cost (TFC) + total variable cost (TVC); TFC remains constant even at zero output.
Average fixed cost (AFC = TFC ÷ q) falls continuously; average variable cost (AVC) and short-run average cost (SAC) are U-shaped.
Short-run marginal cost (SMC = change in TC ÷ change in q) is U-shaped and cuts AVC and SAC at their minimum points.

Long-run costs

In the long run all costs are variable; long-run average cost (LRAC) is usually U-shaped because of returns to scale.
Increasing returns to scale lower LRAC; decreasing returns raise it.

Key terms

Production function: the technical relationship between inputs and maximum output
Marginal product: the change in total product from one more unit of a variable input
Law of variable proportions: the principle that the marginal product of a variable input eventually falls when other inputs are fixed
Total fixed cost: costs that do not change with output, such as rent
Marginal cost: the change in total cost from producing one more unit of output

Important questions with answers

What is a production function?2 marks

A production function shows the technical relationship between the quantities of inputs used and the maximum quantity of output that can be produced with them, given the state of technology, for example q = f(L, K).

Explain the relationship between marginal cost and average cost.3 marks

When marginal cost is less than average cost, average cost falls; when marginal cost equals average cost, average cost is at its minimum; and when marginal cost is greater than average cost, average cost rises. So the MC curve cuts the AC curve from below at its minimum point. Both curves are U-shaped.

Explain the law of variable proportions with its three phases.5 marks

The law of variable proportions states that when more and more units of a variable input, such as labour, are combined with a fixed input, such as land, the marginal product of the variable input first increases, then decreases and may eventually become negative. In the first phase, total product increases at an increasing rate and marginal product rises, because the fixed input is better utilised and specialisation becomes possible. In the second phase, total product increases at a diminishing rate and marginal product falls but remains positive; this phase ends where total product is maximum and marginal product is zero. In the third phase, total product falls and marginal product becomes negative, because too many units of the variable input crowd the fixed input. A rational producer operates in the second phase. The law operates because the fixed input limits the efficiency of additional variable input, and it explains why short-run marginal and average variable costs eventually rise, giving their U-shape.

Quick revision

Short run vs long run.
Law of variable proportions: MP rises, falls, turns negative.
TC = TFC + TVC; AFC falls; AVC, AC, MC U-shaped.
Returns to scale: increasing, constant, decreasing.

Exam tips

Draw TP, AP and MP together and mark where MP = 0 and where MP cuts AP.
Remember: MC cuts AVC and AC from below at their minimum points.

Practice MCQs

Costs that do not change with output are
1. fixed costs
2. variable costs
3. marginal costs
4. average variable costs
Show answer
Answer: (a) fixed costs. Rent is an example.
In the long run
1. all inputs are fixed
2. only labour is fixed
3. all inputs are variable
4. only capital is variable
Show answer
Answer: (c) all inputs are variable. Firms can change plant size.
Total cost equals
1. TFC − TVC
2. AFC × AVC
3. TVC ÷ q
4. TFC + TVC
Show answer
Answer: (d) TFC + TVC. Fixed plus variable.
When MP is zero, TP is
1. maximum
2. rising
3. minimum
4. zero
Show answer
Answer: (a) maximum. Adding more input adds nothing.
Average fixed cost as output increases
1. falls continuously
2. rises
3. is U-shaped
4. remains constant
Show answer
Answer: (a) falls continuously. The same fixed cost is spread over more units.
If doubling all inputs more than doubles output, there are
1. constant returns to scale
2. decreasing returns to scale
3. increasing returns to scale
4. diminishing MP
Show answer
Answer: (c) increasing returns to scale. Output rises more than proportionately.
The marginal cost curve cuts the AVC curve at
1. its maximum point
2. any point
3. zero output
4. its minimum point
Show answer
Answer: (d) its minimum point. When MC < AVC, AVC falls; when MC > AVC, AVC rises.
If TC at 4 units is ₹200 and at 5 units is ₹230, the marginal cost of the 5th unit is
1. ₹46
2. ₹30
3. ₹230
4. ₹50
Show answer
Answer: (b) ₹30. 230 − 200.

All chapters of Class 12 Economics

Written by Kundali IQ from standard, well-established facts to help with revision. This is not an official NCERT publication; always read your textbook too.