#### CA Foundation Business Economics Study Material Chapter 3 Theory of Production and Cost – Fixed Inputs and Variable Inputs

Fixed Inputs (Fixed Factors) and Variable Inputs (Variable Factors)

 Comparison Fixed Inputs Variable Inputs (i) Meaning The factors which cannot be easily and quickly changed and require long time to make adjustment in them with the changes in the level of output are called fixed inputs or fixed factors of production. In other words, factor inputs whose quantity does not vary from day-to-day are called as fixed inputs. The factors which can be easily and quickly changed and readily adjusted with the changes in the level of output are called variable inputs or variable factors of production. In other words, factor inputs whose quantity may vary from day-to-day are called as variable inputs. (ii) Examples Examples of fixed inputs – buildings, machinery, plant, top management, etc. It requires long time to make variations in them. E.g. To construct a new factory building with a larger area and capacity. Examples of variable inputs – ordinary labour, raw-material, power, fuel chemicals, etc. It can be readily changed. (iii) Relation with Output Fixed inputs do not vary with the level of output. Its quantity remains the same, whether the output is more or less or zero in SHORT RUN Variable inputs vary directly with the level of output. Such factors are required more, when output is more; less, when output is less and zero, when output is zero in SHORT RUN. (iv) Cost The cost of the fixed inputs is called FIXED COST. In the short run the firm has to bear the fixed cost even if the output is zero. Since the quantity of fixed inputs remains the same, fixed cost remains the same whatever be the level of output. The cost of the variable inputs is called VARIABLE COST. Since variable inputs vary directly with the level of output, variable costs are also positively related with output. If output is zero, variable cost is also zero. If output is increased variable cost also increases and vice-versa.

Short Run (Short Period) & Long Run (Long Period)

 Comparison Short Run Long Run (i) Meaning The short run is defined as the period of time in which some factors of production or at least one factor is fixed i.e. does not vary with output. Thus, in the short period some factors are FIXED FACTORS E.g. Factory building, machinery, management, etc. and some are VARIABLE FACTORS E.g. Labour, raw-material, power, fuel, etc. The long run is defined as the period of time in which all factors may vary. In the long run, all factors become variable and so there is no distinction between fixed and variable factors. (ii) Scale of Production OR Size of the Firm In the short run, the output is produced with a GIVEN SCALE OF PRODUCTION i.e. the size of plant or firm (and so the production capacity) remains unchanged. Hence, production can be increased or decreased only by changing the amount of variable factors. In the long run, the output is produced with the CHANGE IN THE SCALE OF PRODUCTION i.e. the size of plant or firm can be increased (and so the pro­duction capacity). Hence, production can be increased by varying all factors i.e. fixed factors (of short period) as well as variable factors. (iii) Produc­tion Law The production function which is studied in the short run period is called as the Law of Variable Proportions. The production function which is stud­ied in the long run period is called as the Law of Returns to Scale. (iv) Decisions about Change in factors The decisions to change the amount of variable factors (like raw material, labour, etc.) are taken very frequently depending upon changes in demand of the commod­ity. Hence, short run is the ‘ACTUAL PRO­DUCTION PERIOD’ during which some factors are fixed while some are variable. Thus, firms operate in the short run period. The decisions to change the amount of fixed factors i.e. scale of production or to close down the firm are taken only once in a while. Hence, long run is the ‘PLANNING PERIOD’. Thus, firms plan in the long run period. (v) Nature of Supply In the short run period, supply can be adjusted upto a limited extent as per changes in demand. In other words, supply is relatively inelastic. In the long run period, supply can be fully adjusted as per changes in demand. In other words, supply is relatively elastic. (vi) Nature of Cost In short run period, cost is classified as FIXED COST and VARIABLE COST. Fixed cost is the cost of fixed inputs and Variable cost is the cost of variable inputs. Fixed cost is the main feature of short run period In long run period ALL COSTS ARE VARIABLE. Variable cost is the main feature of long run period. (vii) Effect on Price In short-run, the price determination of a commodity is more influenced by – (a) The demand forces than supply forces because supply in short-run is rela­tively inelastic, and (b) The UTILITY of the commodity. The short-run price is called SUB-NOR­MAL PRICE In long-run, the price determination of a commodity is more influenced by- (a) The supply forces than demand forces because supply in long-run is relatively elastic, and (b) The COST OF PRODUCTION of the commodity. The long-run price is called NORMAL PRICE. (viii) Average Cost Curve The short-run average cost curve is ‘U’ shaped. Its U-shape is explained with the Law of Variable Proportions. The long-run average cost curve is also U shaped. But its U- shape is not as prominent as short-run average cost curve. Its U-shape is explained with the Law of Returns to Scale. Long-run average cost curve is also called ‘PLANNING CURVE’ and ‘ENVELOPE CURVE’. (ix) Profit of Firms In the short-run period – The firms under perfect competition on being at equilibrium may earn normal profits, super normal profits or incur losses; The monopoly firm on being at equi­librium may earn normal profits, super normal profits or incur losses; The firms under monopolistic competi­tion on being at equilibrium may earn normal profits, super normal profits or incur losses. In the long run period- The firms under perfect competi­tion earn only NORMAL PROFITS and operate at optimum level. The monopoly firm can earn SUPER NORMAL PROFITS and operate at sub-optimum level. The firms under monopolistic competition earn only NORMAL PROFITS and operate at sub-opti­mum level.