Year: 2020

Cost and revenue analysis refers to examining the cost of production and sales revenue of a production unit or firm under various conditions. The objective of a firm is to earn profit, and not to make loss. However, a firm’s profit or loss is primarily determined by its costs and revenue. In simple terms, profit / loss is defined as the difference between the total revenue and the total cost i.e.,

Profit (or) Loss = Total Revenue – Total Cost

As costs and revenue are very important to decide the production behaviour of a firm and its supply behaviour in the market, it is necessary to understand the cost and revenue concepts.

Costs

Companies incur costs in many ways. Costs result from the production of goods, the purchase of inventory, the operating of the business, and the purchase of assets. These costs include the fixed and variable costs associated with production, depreciation and investment costs, and general and administrative costs. Costs also include opportunity costs, sunk costs and marginal costs. Cost analysis identifies and investigates the sources and components of these costs. Cost analysis has several different names, including cost allocation, cost-benefit analysis and cost-effectiveness analysis.

What Cost Analysis Reveals

Cost analysis helps a company determine the expected costs and benefits of a particular asset, new product, or plan of action before it makes the requisite investment. An in-depth cost analysis can reveal hidden costs embedded in a company’s normal way of doing business and the unanticipated costs of certain actions. Identifying and then stripping out costs can help a company increase its profitability and long-term viability. Cost analysis also aids companies in changing their service and product delivery procedures to those that are more cost-efficient and effective.

Revenues

Companies generate revenues from sales of their products and services. To generate more revenues, companies can increase the prices of existing products and services, offer add-on services for an additional price, or introduce new products or services at a higher price point. Companies can also increase revenues by increasing the quantity sold. Firms accomplish this by lowering prices or increasing their marketing efforts to stimulate demand.

What Revenue Analysis Reveals

Revenue analysis helps companies determine how to increase their revenues significantly. When combined with cost analysis, it helps companies do this while keeping costs at a minimum. Revenue analysis aids companies in assessing which course of action produces the highest increase in revenue with the least effort. For example, a company determines that it takes a series of press releases, website testimonials, and well-placed classified ads to drastically increase sales of a particular product, but it also determines that adding a low-cost add-on to a higher priced service would have the same effect.

Break-Even

The break-even point for a product or service occurs when revenue generated by the product equals the costs incurred in producing, selling and delivering the product. Break-even analysis blends cost and revenue analysis to help companies determine if a new product or service makes financial sense. While companies may focus solely on cost analysis for the purpose of cost reduction, most companies use revenue analysis combined with cost analysis to choose the revenue option that produces the most profit.

A monopoly refers to when a company and its product offerings dominate one sector or industry. Monopolies can be considered an extreme result of free-market capitalism in that absent any restriction or restraints, a single company or group becomes large enough to own all or nearly all of the market (goods, supplies, commodities, infrastructure, and assets) for a particular type of product or service. The term monopoly is often used to describe an entity that has total or near-total control of a market.

Monopolies typically have an unfair advantage over their competition since they are either the only provider of a product or control most of the market share or customers for their product. Although monopolies might differ from industry-to-industry, they tend to share similar characteristics that include:

• High or no barriers to entry:Competitors are not able to enter the market, and the monopoly can easily prevent competition from developing their foothold in an industry by acquiring the competition.
• Single seller:There is only one seller in the market, meaning the company becomes the same as the industry it serves.
• Price maker:The company that operates the monopoly decides the price of the product that it will sell without any competition keeping their prices in check. As a result, monopolies can raise prices at will.
• Economies of scale:A monopoly often can produce at a lower cost than smaller companies. Monopolies can buy huge quantities of inventory, for example, usually a volume discount. As a result, a monopoly can lower its prices so much that smaller competitors can’t survive. Essentially, monopolies can engage in price wars due to their scale of their manufacturing and distribution networks such as warehousing and shipping, that can be done at lower costs than any of the competitors in the industry.

Determination of price under monopoly

Under Monopoly every seller wants to earn maximum Profit.

This fact Prof. Marshall has stated that monopolist wants to earn “Maximum Monopoly Gain” by selling his goods.

This thing Mrs. Robinson has stated as Net Monopoly Revenue.

Now, the important question arises that how monopolist should fix his price, so that he may earn maximum profit? On this point two economists written above are of this opinion the price determination under monopoly condition is similar to those of perfect competition.

The only difference is that in perfect competition the average revenue curve and marginal revenue curve are same and parallel to X-axis where as in Monopoly these curves are downwards sloping curves. The Monopolist behaves like a firm. His aim is maximization of profits and if there are losses, then minimization of losses. The profits are maximized when marginal cost is equal to marginal revenue. The losses are minimum where marginal cost is equal to marginal revenue but afterwards marginal cost must be rising.

A Monopolist being the only producer and seller of that commodity can determine its price and the quantity of its production or supply. He cannot do both the things simultaneously. Either he fixes the price and leaves the output to be determined by the consumer demand at that price or he can fix the output to be produced and leave the price to be determined by the consumers’ demand for his product. But it is a common experience that he leaves the price to the market mechanism and determines the volume of output. Under no circumstances, he will be ready to bear losses.

If, in a short period, the cost of production of a commodity is zero, he will go on producing it to the extent or so long the marginal revenue from the sale of that commodity does not fall to zero. As soon as the marginal reserve is zero he will not increase its supply.

Some economists think that, in a short period, three different situations may arise before the monopolist:

(i) When the monopolist earns abnormal profits,

(ii) When he gets only normal profits, and

(iii) When he suffers losses.

The explanation and diagrams of these situations are given below:

On the point E the firm is in equilibrium when MC = MR. Thereafter MC curve starts to rise. Under the condition, OP is the price and OQ is the ‘total production’ of the commodity so determined. In order to calculate profits or losses, we will have to measure the difference between AR and AC. If AR > AC, the difference between the two is profit per unit and by multiply it with total number of units produced we can get total profit.

In the first figure RQ = OP is the price, TO is the cost of production per unit. Thus, RS =PT is unit for profit. On the OQ quantity of production, total profit is PTSR shaded area which is abnormal profit. In the second figure RQ = OP is the determined price and RQ is the average cost. Under this condition, there will be only normal profit.

In the figure three also price per unit is RQ = OP but cost per unit is SQ. Thus, SR (TP) is loss per unit. As a result TPRS shaded area will be the total loss. But this loss is only short period phenomenon. In the long period, this loss will disappear, under that condition and situation, only profit will be earned.

Determination of Price in the Long Period

In the long period the monopolist introduces changes in his equipment’s and techniques of production. During this period in order to gain excess profit, he will change efficiency and capacity of his resources according to his need. But the determination of the quantity of production follows, the same line as under short period.

This is clear from the following figure:

In this figure LMC and LMR intersect each other at the point E and after that LMC goes on rising. Thus OQ production is determined and OP is the price. But average cost is SQ. So profit per unit is RS and at OQ output the total profit is PTSR.

Under Price Competition AR =MR, where-as under Monopoly MR <AR.

Under perfect competition price is determined by the interaction of total demand and supply. This price is acceptable to all the firms in the industry. No firm can change this price. So, average revenue and marginal revenue, at every level of production, will be constant and equal. Their curves are parallel to X-axis.

Under Monopoly, to sell every additional unit of the commodity price will have to be lower. In this way, with the sale of every additional unit, average and marginal income goes on falling. But the decrease in average revenue is relatively less sharp than the decrease in marginal revenue, It is because marginal revenue is limited to one unit, whereas in case of average revenue, the decrease price is divided by the number of units. Therefore, the fall in average revenue has relatively less slope. That is the reason why marginal revenue is less than average revenue.

In monopolistic competition, since the product is differentiated between firms, each firm does not have a perfectly elastic demand for its products. In such a market, all firms determine the price of their own products. Therefore, it faces a downward sloping demand curve. Overall, we can say that the elasticity of demand increases as the differentiation between products decreases.

Fig. 1 above depicts a firm facing a downward sloping, but flat demand curve. It also has a U-shaped short-run cost curve.

Conditions for the Equilibrium of an individual firm

The conditions for price-output determination and equilibrium of an individual firm are as follows:

1. MC = MR
2. The MC curve cuts the MR curve from below.

In Fig. 1, we can see that the MC curve cuts the MR curve at point E. At this point,

• Equilibrium price = OP and
• Equilibrium output = OQ

Now, since the per unit cost is BQ, we have

• Per unit super-normal profit (price-cost) = AB or PC.
• Total super-normal profit = APCB

The following figure depicts a firm earning losses in the short-run.

From Fig. 2, we can see that the per unit cost is higher than the price of the firm. Therefore,

• AQ > OP (or BQ)
• Loss per unit = AQ – BQ = AB
• Total losses = ACPB

Long-run equilibrium

If firms in a monopolistic competition earn super-normal profits in the short-run, then new firms will have an incentive to enter the industry. As these firms enter, the profits per firm decrease as the total demand gets shared between a larger number of firms. This continues until all firms earn only normal profits. Therefore, in the long-run, firms, in such a market, earn only normal profits.

As we can see in Fig. 3 above, the average revenue (AR) curve touches the average cost (ATC) curve at point X. This corresponds to quantity Q₁ and price P₁. Now, at equilibrium (MC = MR), all super-normal profits are zero since the average revenue = average costs. Therefore, all firms earn zero super-normal profits or earn only normal profits.

It is important to note that in the long-run, a firm is in an equilibrium position having excess capacity. In simple words, it produces a lower quantity than its full capacity. From Fig. 3 above, we can see that the firm can increase its output from Q₁ to Q₂ and reduce average costs. However, it does not do so because it reduces the average revenue more than the average costs. Hence, we can conclude that in monopolistic competition, firms do not operate optimally. There always exists an excess capacity of production with each firm.

In case of losses in the short-run, the firms making a loss will exit from the market. This continues until the remaining firms make normal profits only.

The term oligopoly has been derived from two Greek words, ‘oligoi’ means few and ‘poly’ means control.

Therefore, oligopoly refers to a market form in which there is a control of few sellers on the market. These sellers deal either in homogenous or differentiated products.

Oligopoly is one of the forms of an imperfectly competitive market In India the aviation and telecommunication industries are the perfect examples of oligopoly market form. The aviation industry has only few airlines, such as Kingfisher, Air India, Spice Jet, and Indigo.

On the other hand, there are few telecommunication service providers, including Airtel, Vodafone, MTS, Dolphin, and Idea. These organizations are closely interdependent on each other This is because each organization formulates its own pricing policy by taking into account the pricing policies of other competitors existing in the market.

Characteristics of oligopoly:

(i) Few sellers and many buyers

(ii) Homogeneous or differentiated products

(iii) Barriers to entry and exit

(iv) Mutual interdependence among organizations

(v) Existence of price rigidity

(vi) Lack of uniformity in the size of organizations

Oligopoly Features

 The Oligopoly Market characterized by few sellers, selling the homogeneous or differentiated products. In other words, the Oligopoly market structure lies between the pure monopoly and monopolistic competition, where few sellers dominate the market and have control over the price of the product.

Under the Oligopoly market, a firm either produces

1. Homogeneous Product

The firms producing the homogeneous products are called as Pure or Perfect Oligopoly. It is found in the producers of industrial products such as aluminum, copper, steel, zinc, iron, etc.

2. Heterogeneous Product

The firms producing the heterogeneous products are called as Imperfect or Differentiated Oligopoly. Such type of Oligopoly is found in the producers of consumer goods such as automobiles, soaps, detergents, television, refrigerators, etc.

Features of Oligopoly Market

(i) Few Sellers

Under the Oligopoly market, the sellers are few, and the customers are many. Few firms dominating the market enjoys a considerable control over the price of the product.

(ii) Interdependence

It is one of the most important features of an Oligopoly market, wherein, the seller has to be cautious with respect to any action taken by the competing firms. Since there are few sellers in the market, if any firm makes the change in the price or promotional scheme, all other firms in the industry have to comply with it, to remain in the competition.

Thus, every firm remains alert to the actions of others and plan their counterattack beforehand, to escape the turmoil. Hence, there is a complete interdependence among the sellers with respect to their price-output policies.

(iii) Advertising

Under Oligopoly market, every firm advertises their products on a frequent basis, with the intention to reach more and more customers and increase their customer base. This is due to the advertising that makes the competition intense.

If any firm does a lot of advertisement while the other remained silent, then he will observe that his customers are going to that firm who is continuously promoting its product. Thus, in order to be in the race, each firm spends lots of money on advertisement activities.

(iv) Competition

It is genuine that with a few players in the market, there will be an intense competition among the sellers. Any move taken by the firm will have a considerable impact on its rivals. Thus, every seller keeps an eye over its rival and be ready with the counterattack.

(v) Entry and Exit Barriers

The firms can easily exit the industry whenever it wants, but has to face certain barriers to entering into it. These barriers could be Government license, Patent, large firm’s economies of scale, high capital requirement, complex technology, etc. Also, sometimes the government regulations favor the existing large firms, thereby acting as a barrier for the new entrants.

(vi) Lack of Uniformity

There is a lack of uniformity among the firms in terms of their size, some are big, and some are small.

Since there are less number of firms, any action taken by one firm has a considerable effect on the other. Thus, every firm must keep a close eye on its counterpart and plan the promotional activities accordingly.

In oligopolistic market situation, a small number of organizations compete with each other. The sales of each organization under oligopoly depend on the price charged by it as well as the price charged by other organizations in the market. If an organization lowers down its prices, its sales would increase.

However, the sales of other organizations in the market would decrease. In such a scenario, other organizations would also lower down their prices. Therefore, the price and output are indeterminate under oligopoly. In other market structures, such as perfect competition and monopoly, price and output are determined by taking into account demand, supply, revenue, and cost factors.

In such type of market structures, the actions and reactions of other organizations related to any pricing-decision are ignored. According to Miller, “in a perfectly competitive model, each firm ignores the reaction of other firms because each firm can sell all that it wants at the going market price. In the pure monopoly model, the monopolist does not have to worry about the reaction of rivals since by definition they are none. However, there is interdependence of firms in the oligopoly. Hence, the decisions of a firm will affect the other firms, which in turn will react in way that affects the initial firm. This causes uncertainty. Thus, it is a difficult task to draw the demand curve of an oligopolist.”

The main reasons for indeterminate price and output under oligopoly are as follows:

1. Different Behavior Patterns

Imply that under oligopoly, the behavior patterns differ from organization to organization For example, under oligopoly, organizations may cooperate with each other in setting the pricing policy or they may act as competitors.

According to Baumol, “under the circumstances a very wide variety of behavior patterns becomes possible. Rivals may decide to get together and co-operate in the pursuit of their objectives so far as the law allows, or at the other extreme they may try to fight each other to the death.” Thus, under oligopoly, the price and output of organizations differ in different behavior patterns.

2. Indeterminate Demand Curve

Implies that the demand curve is unknown under oligopoly due to different behavior patterns of organizations. Under oligopoly, every organization keeps an eye on the actions of rivals and makes strategies accordingly.

Therefore, the demand curve under oligopoly is never stable and shifts in response to the actions of rivals. According to Baumol, “the firm’s attempts to outguess one another are then likely to lead to interplay of anticipated strategies and counter strategies which is tangled beyond hope of direct analysis.”

3. Non-profit Motive

Implies that under oligopoly, organizations are not only indulged in maximizing profit, but also compete with each other for non-profit motive. For example, organizations use advertising and other tools to promote their sales. These motives lead to indeterminate price and output under oligopoly.

Business enterprise needs to know the demand for its product. An existing unit must know current demand for its product in order to avoid underproduction or over production. The current demand should be known for determining pricing and promotion policies so that it is able to secure optimum sales or maximum profit. Such information about the current demand for the firm‟s product is known as demand estimation.

Demand Estimation is the process of finding current values of demand for various values of prices and other determining variables.

Steps in Demand Estimation

1. Identification of independent variables such as price, price of substitutes, population, per capita income, advertisement expenditure etc.,
2. collection of data on the variables from past records, publications of various agencies etc.,
3. Development a mathematical model or equation that indicates the relationship between independent and dependent variables.
4. Estimation of the parameters of the model. I.e., to estimate the unknown values of the parameters of the model.
5. Development of estimates based on the model.

Tools and techniques for demand estimation includes

1. Consumer surveys.
2. Consumer clinics and focus groups
3. Market Experiment.
4. Statistical techniques.

Demand Forecasting

Accurate demand forecasting is essential for a firm to enable it to produce the required quantities at the right time and to arrange well in advance for the various factors of production. Forecasting helps the firm to assess the probable demand for its products and plan its production accordingly.

Demand Forecasting refers to an estimate of future demand for the product. It is an “objective assessment of the future course of demand”. It is essential to distinguish between forecast of demand and forecast of sales. Sales forecast is important for estimating revenue, cash requirements and expenses. Demand forecast relate to production inventory control, timing, reliability of forecast etc…

Levels of Demand forecasting

Demand forecasting may be undertaken at three different levels;

1. Macro level: Micro level demand forecasting is related to the business conditions prevailing in the economy as a whole.
2. Industry Level: it is prepared by different trade association in order to estimate the demand for particular industries products. Industry includes number of firms. It is useful for inter-industry comparison.
3. Firm level: it is more important from managerial view point as it helps the management in decision making with regard to the firms demand and production.

Types of Demand Forecasting

Based on the time span and planning requirements of business firms, demand forecasting can be classified into short term demand forecasting and long term demand forecasting.

Short term Demand forecasting: Short term Demand forecasting is limited to short periods, usually for one year. Important purposes of Short term Demand forecasting are given below

1. Making a suitable production policy to avoid over production or underproduction.
2. Helping the firm to reduce the cost of purchasing raw materials and to control inventory.
3. Deciding suitable price policy so as to avoid an increase when the demand is low.
4. Setting correct sales target on the basis of future demand and establishment control. A high target may discourage salesmen.
5. Forecasting short term financial requirements for planned production.
6. Evolving a suitable advertising and promotion programme.

Long term Demand Forecasting:  this forecasting is meant for long period. The important purpose of long term forecasting is given below;

1. Planning of a new unit or expansion of existing on them basis of analysis of long term potential of the product demand.
2. Planning long term financial requirements on the basis of long term sales forecasting.
3. Planning of manpower requirements can be made on the basis of long term sales forecast.
4. To forecast future problems of material supply and energy crisis.

Demand forecasting is a vital tool for marketing management. It is also helpful in decision making and forward planning. It enables the firm to produce right quantities at right time and arrange well in advance for the factors of production.

The law of returns to scale describes the relationship between outputs and scale of inputs in the long-run when all the inputs are increased in the same proportion. In the words of Prof. Roger Miller, “Returns to scale refer to the relationship between changes in output and proportionate changes in all factors of production. To meet a long-run change in demand, the firm increases its scale of production by using more space, more machines and labourers in the factory’.

Assumptions

(i) All factors (inputs) are variable but enterprise is fixed.

(ii) A worker works with given tools and implements.

(iii) Technological changes are absent.

(iv) There is perfect competition.

(v) The product is measured in quantities.

Explanation

Given these assumptions, when all inputs are increased in unchanged proportions and the scale of production is expanded, the effect on output shows three stages: increasing returns to scale, constant returns to scale and diminishing returns to scale.

1. Increasing Returns to Scale

Returns to scale increase because the increase in total output is more than proportional to the increase in all inputs.

The table reveals that in the beginning with the scale of production of (1 worker + 2 acres of land), total output is 8. To increase output when the scale of production is dou­bled (2 workers + 4 acres of land), total returns are more than doubled. They become 17. Now if the scale is trebled (3 workers + о acres of land), returns become more than three-fold, i.e., 27. It shows increasing returns to scale. In the figure RS is the returns to scale curve where R to С portion indicates increasing returns.

Causes of Increasing Returns to Scale

Returns to scale increase due to the following reasons:

(i) Indivisibility of Factors

Returns to scale increase because of the indivisibility of the factors of production. Indivisibility means that machines, management, labour, finance, etc. cannot be available in very small sizes. They are available only in certain minimum sizes. When a business unit expands, the returns to scale increase because the indivisible factors are employed to their maximum capacity.

(ii) Specialization and Division of Labour

Increasing returns to scale also result from specialization and division of labour. When the scale of the firm is expanded there is wide scope of speciali­zation and division of labour. Work can be divided into small tasks and workers can be concentrated to narrower range of processes. For this, specialised equipment can be installed. Thus with specialization, efficiency increases and increasing returns to scale follow.

(iii) Internal Economies

As the firm expands, it enjoys internal economies of production. It may be able to install better machines, sell its products more easily, borrow money cheaply, procure the services of more efficient manager and workers, etc. All these economies help in increasing the returns to scale more than proportionately.

(iv) External Economies

A firm also enjoys increasing returns to scale due to external econo­mies. When the industry itself expands to meet the increased long-run demand for its product, external economies appear which are shared by all the firms in the industry.

When a large number of firms are concentrated at one place, skilled labour, credit and transport facilities are easily available. Subsidiary industries crop up to help the main industry. Trade journals, research and training centres appear which help in increasing the productive efficiency of the firms. Thus these external economies are also the cause of increasing returns to scale.

2. Constant Returns to Scale

Returns to scale become constant as the increase in total output is in exact proportion to the increase in inputs. If the scale of production in increased further, total returns will increase in such a way that the marginal returns become constant. In the table, for the 4th and 5th units of the scale of production, marginal returns are 11, i.e., returns to scale are constant. In the figure, the portion from С to D of the RS curve is horizontal which depicts constant returns to scale. It means that increments of each input are constant at all levels of output.

Causes of Constant Returns to Scale

Returns to scale are constant due to:

(i) Internal Economies and Diseconomies: But increasing returns to scale do not continue indefinitely. As the firm expands further, internal economies are counterbalanced by internal diseconomies. Returns increase in the same proportion so that there are constant returns to scale over a large range of output.

(ii) External Economies and Diseconomies: The returns to scale are constant when external diseconomies and economies are neutralised and output increases in the same proportion.

(iii) Divisible Factors: When factors of production are perfectly divisible, substitutable, and homogeneous with perfectly elastic supplies at given prices, returns to scale are constant.

3. Diminishing Returns to Scale

Returns to scale diminish because the increase in output is less than proportional to the increase in inputs. The table shows that when output is increased from the 6th, 7th and 8th units, the total returns increase at a lower rate than before so that the marginal returns start diminishing successively to 10, 9 and 8. In the figure, the portion from D to S of the RS curve shows diminishing returns.

Causes of Diminishing Returns to Scale

Constant returns to scale is only a passing phase, for ultimately returns to scale start diminishing. Indivisible factors may become inefficient and less productive. Business may become unwieldy and produce problems of supervision and coordination. Large management creates difficulties of control and rigidities. To these internal diseconomies are added external diseconomies of scale.

These arise from higher factor prices or from diminishing productivities of the factors. As the industry continues to expand, the demand for skilled labour, land, capital, etc. rises. There being perfect competition, inten­sive bidding raises wages, rent and interest. Prices of raw materials also go up. Transport and marketing difficulties emerge. All these factors tend to raise costs and the expansion of the firms leads to diminish­ing returns to scale so that doubling the scale would not lead to doubling the output.

For the management increasing, decreasing or constant returns to scale reflect changes in pro­duction efficiency that result from scaling up productive inputs. But returns to scale is strictly a production and cost concept. Management’s decision on what to produce and how much to produce must be based upon the demand for the product. Therefore, demand and other factors must also be considered in decision making.

Laws of Constant Returns

 The Law of Constant Returns is said to operate when the additional investment of labour and capital yields the same return as before.

It means the return from investment remains the same as the business is expanded or contracted.

In other-words, it can be said that “whatever the scale of production, the cost of the product per unit remains the same.”

According to Stigler – “When all the productive services are increased in a given proportion, the product is increased in the same proportion.”

Law of Constant Return remains active for some-time. From where the activeness of Law of Increasing Return ends, from there the Law of Constant Return starts and after the end of the activeness of this Law of Diminishing Return starts operation.

In other-words, it can be said that when the business moves towards the optimum, the returns increase and when it goes beyond the optimum the returns decrease. But if after having reached the optimum point, the industry is stabilized at the level of output, the returns continue to be the same; and they are said to be constant.

This law can be illustrated by the following example:

From this table it is clear that by increase in the unit of labour and capital, total production increases but the marginal production remains constant i.e., 30 is the constant figure; and this figure is Law of Constant Return.

Diagrammatic Representation:

This Law of Constant Returns can be represented in a diagram as follows:

On OX axis unit of labour and capital and on OY axis marginal production of fan has been shown. AB line is the Law of Constant Return because it shows that in-spite of increase in the unit of labour and capital marginal production of fan is the same. In other-words, here AB line is the Law of Constant Return.

Why Law of Constant Returns?

In every industry, we find the influence of man and nature. Nature controls the supply of raw-materials while man directs the manufacturing side. If there is an industry where the cost of raw-materials and the manufacturing costs are half and half, we can say that both man and nature influence equally. Such an industry would be subject to the Law of Constant Returns. For example – The woolen blanket weaving industry. Here the cost of wool is supposed to cost as much as the other manufacturing costs put in the manufacturing.

Further, if there is an integration of the extractive and manufacturing industries like sugar-making and cane-growing, steel making and iron-ore mining the Law of Constant Returns may operate. Here, the two aspects of the industry are combined, viz., the agricultural aspect which is subject to the law of diminishing returns and the manufacturing aspect which is subject to the Law of Increasing Returns.

It is possible for these two tendencies to counter­balance each other with the result that the Law of Constant Returns may operate. Thus, we find that in every industry there are two tendencies and constantly at work viz., one of diminishing returns and the other of increasing returns. Whenever this scale of production is increased the cost of raw materials and other factors may go up on account of increased demand.

This tends to raise the cost of production per unit or to bring about the operation of the Law of Diminishing Returns. But the larger the scale the greater the economies in the use of machinery, division of labour, buying and selling, research and publicity etc.

In actual life, however, either the tendency of diminishing returns is stronger or the increasing returns tendency is stronger. Thus, the operation of the Law of Constant Returns is rather rare and if at all it operates, it lasts only for a short period of time.

There are mainly two factors which give rise to the Law of Increasing Returns to scale:

1. Indivisibilities of the factors of production.
2. Specialisation of factors of production.

In economics, production theory explains the principles in which the business has to take decisions on how much of each commodity it sells and how much it produces and also how much of raw material ie., fixed capital and labor it employs and how much it will use. It defines the relationships between the prices of the commodities and productive factors on one hand and the quantities of these commodities and productive factors that are produced on the other hand.

Production is a process of combining various inputs to produce an output for consumption. It is the act of creating output in the form of a commodity or a service which contributes to the utility of individuals.

In other words, it is a process in which the inputs are converted into outputs.

Function

The Production function signifies a technical relationship between the physical inputs and physical outputs of the firm, for a given state of the technology.

Q = f (a, b, c, . . . . . . z)

Where a,b,c ….z are various inputs such as land, labor ,capital etc. Q is the level of the output for a firm.

If labor (L) and capital (K) are only the input factors, the production function reduces to 

Q = f(L, K)

Production Function describes the technological relationship between inputs and outputs. It is a tool that analysis the qualitative input – output relationship and also represents the technology of a firm or the economy as a whole.

Features of Production Function:

Following are the main features of production function:

1. Substitutability:

The factors of production or inputs are substitutes of one another which make it possible to vary the total output by changing the quantity of one or a few inputs, while the quantities of all other inputs are held constant. It is the substitutability of the factors of production that gives rise to the laws of variable proportions.

2. Complementarity:

The factors of production are also complementary to one another, that is, the two or more inputs are to be used together as nothing will be produced if the quantity of either of the inputs used in the production process is zero.

The principles of returns to scale is another manifestation of complementarity of inputs as it reveals that the quantity of all inputs are to be increased simultaneously in order to attain a higher scale of total output.

3. Specificity:

It reveals that the inputs are specific to the production of a particular product. Machines and equipment’s, specialized workers and raw materials are a few examples of the specificity of factors of production. The specificity may not be complete as factors may be used for production of other commodities too. This reveals that in the production process none of the factors can be ignored and in some cases ignorance to even slightest extent is not possible if the factors are perfectly specific.

Production involves time; hence, the way the inputs are combined is determined to a large extent by the time period under consideration. The greater the time period, the greater the freedom the producer has to vary the quantities of various inputs used in the production process.

In the production function, variation in total output by varying the quantities of all inputs is possible only in the long run whereas the variation in total output by varying the quantity of single input may be possible even in the short run.

Production analysis basically is concerned with the analysis in which the resources such as land, labor, and capital are employed to produce a firm’s final product. To produce these goods the basic inputs are classified into two divisions:

Variable Inputs

Inputs those change or are variable in the short run or long run are variable inputs.

Fixed Inputs

Inputs that remain constant in the short term are fixed inputs.

Cost Function

Cost function is defined as the relationship between the cost of the product and the output. Following is the formula for the same:

C = F [Q]

Cost function is divided into namely two types:

Short Run Cost

Short run cost is an analysis in which few factors are constant which won’t change during the period of analysis. The output can be changed i.e, increased or decreased in the short run by changing the variable factors.

Following are the basic three types of short run cost:

Long Run Cost

Long-run cost is variable and a firm adjusts all its inputs to make sure that its cost of production is as low as possible.

Long run cost = Long run variable cost

In the long run, firms don’t have the liberty to reach equilibrium between supply and demand by altering the levels of production. They can only expand or reduce the production capacity as per the profits. In the long run, a firm can choose any amount of fixed costs it wants to make short run decisions.

Law of Variable Proportions

The law of variable proportions has following three different phases:

• Returns to a Factor
• Returns to a Scale
• Isoquants

Returns to a Factor

Increasing Returns to a Factor

Increasing returns to a factor refers to the situation in which total output tends to increase at an increasing rate when more of variable factor is mixed with the fixed factor of production. In such a case, marginal product of the variable factor must be increasing. Inversely, marginal price of production must be diminishing.

Constant Returns to a Factor

Constant returns to a factor refers to the stage when increasing the application of the variable factor does not result in increasing the marginal product of the factor – rather, marginal product of the factor tends to stabilize. Accordingly, total output increases only at a constant rate.

Diminishing Returns to a Factor

Diminishing returns to a factor refers to a situation in which the total output tends to increase at a diminishing rate when more of the variable factor is combined with the fixed factor of production. In such a situation, marginal product of the variable must be diminishing. Inversely the marginal cost of production must be increasing.

Returns to a Scale

If all inputs are changed simultaneously or proportionately, then the concept of returns to scale has to be used to understand the behavior of output. The behavior of output is studied when all the factors of production are changed in the same direction and proportion. Returns to scale are classified as follows:

• Increasing returns to scale: If output increases more than proportionate to the increase in all inputs.
• Constant returns to scale: If all inputs are increased by some proportion, output will also increase by the same proportion.
• Decreasing returns to scale: If increase in output is less than proportionate to the increase in all inputs.

For example: If all factors of production are doubled and output increases by more than two times, then the situation is of increasing returns to scale. On the other hand, if output does not double even after a 100 per cent increase in input factors, we have diminishing returns to scale.

The general production function is Q = F (L, K)

An international financial institution (IFI) is a financial institution that has been established (or chartered) by more than one country, and hence are subjects of international law. Its owners or shareholders are generally national governments, although other international institutions and other organizations occasionally figure as shareholders. The most prominent IFIs are creations of multiple nations, although some bilateral financial institutions (created by two countries) exist and are technically IFIs. The best known IFIs were established after World War II to assist in the reconstruction of Europe and provide mechanisms for international cooperation in managing the global financial system.

Today, the world’s largest IFI is the European Investment Bank, with a balance sheet size of €573 billion in 2016. This compares to the two components of the World Bank, the IBRD (assets of $358 billion in 2014) and the IDA (assets of $183 billion in 2014). For comparison, the largest commercial banks each have assets of c.$2,000-3,000 billion.

In many parts of the world, international financial institutions (IFIs) play a major role in the social and economic development programs of nations with developing or transitional economies. This role includes advising on development projects, funding them and assisting in their implementation.

Characterized by AAA-credit ratings and a broad membership of borrowing and donor countries, each of these institutions operates independently. All however, share the following goals and objectives:

• To reduce global poverty and improve people’s living conditions and standards;
• To support sustainable economic, social and institutional development; and
• To promote regional cooperation and integration.

IFIs achieve these objectives through loans, credits and grants to national governments. Such funding is usually tied to specific projects that focus on economic and socially sustainable development. IFIs also provide technical and advisory assistance to their borrowers and conduct extensive research on development issues. In addition to these public procurement opportunities, in which multilateral financing is delivered to a national government for the implementation of a project or program, IFIs are increasingly lending directly to non-sovereign guaranteed (NSG) actors. These include sub-national government entities, as well as the private sector.

Canada is a partner and shareholder in the World Bank, which is the major global IFI, and in several regional development banks. This membership permits Canadian firms and individuals to compete for procurement opportunities in bank-funded projects and programs.