1. Why does one need to understand Production function?

In microeconomics and macroeconomics a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs. This function is an assumed technological relationship, based on the current state of engineering knowledge; it does not represent the result of economic choices, but rather is an externally given entity that influences economic decision-making. Almost all economic theories pre-suppose a production function, either on the firm level or the aggregate level. In this sense, the production function is one of the key concepts of mainstream neoclassical theories. For managers, an understanding of the basic concepts of production provides a solid conceptual framework for decisions involving the allocation of a firms resources both in the short run and in the long run. Following are two such key management principles1. Careful Planning can help a firm to use its resources in a rational manner. In the short run analysis, we found that a firm has three stages of production and the stage II is the only stage for a rational firm to operate. However, the firm may find itself in stage I or III as the production levels do not depend on how much a comp-any wants to produce but on how much its customer wants to buy. The Exhibit-1 shows a short run production function where stage-II applies to production levels between Q1 = 200 and Q2 = 275. If people want to buy less than 200 units or more than 275 units, for example, then in the short run the firm would be forced to operate in either stage-I or stage-III. The information above implies that for a firm to avoid having to operate in either stage-I or stage-III, there must be careful planning regarding the amount of fixed inputs that will be used along with the variable ones. In business this is called Capacity Planning. Good capacity planning requires two basic elements: i) Accurate forecasts of demands ii) Effective communication between the production and marketing functions.

2. Managers must understand the marginal benefits and cost of each decision involving the allocation of scarce resources. : One of the most difficult subjects to learn is the use of isoquants and isocasts in production theory: as it is far removed from the reality of the real world of business. The essence of the model, however, is that it tells managers about allocation of scarce resources; that certain trade-offs in terms of benefit and costs are involved. In the real world analysis of production, the data on the marginal products of each input may not be known. Thus, a manager may be unable to find the optional combination of inputs. Nonetheless, managers can utilize the concept of trade-offs in their decision-making regardless of whether detailed quantitative information exists.

2. Why does one need to understand the Demand Function? Demand Function: The demand for a commodity arises from the consumers willingness and ability to purchase the commodity. The demand theory postulates that the quantity demanded of a commodity is a function of or depends on not only the price of a commodity but also income, price of related goods- both substitutes and complements, taste of consumer, price exception and all other factors. Demand function is a comprehensive formulation which specifies the factors that influence the demand for the product.

3. Why does one need to understand Consumption Function? Answer: Consumption Function, in economics, is the relationship between consumer spending and the various factors determining it. At the household or family level, these factors may include income, wealth, expectations about the level and riskiness of future income or wealth, interest rates, age, education, and family size. The consumption function is also influenced by the consumers preferences (e.g., patience, or the willingness to delay gratification); by the consumers attitude toward risk and by whether the consumer wishes to leave a bequest. In macroeconomic models the consumption function tracks total aggregate consumption expenditures; for simplicity it is assumed to depend on a basic subset of the factors economists believe are important at the household level. Analysis of consumption expenditure is important for understanding short-term (business cycle) fluctuations and for examining long-run issues such as the level of interest rates and the size of the capital stock (the amount of buildings, machinery, and other reproducible assets useful in producing goods and services). In principle, the consumption function provides answers to both short-run and long-run questions. In the long run, since income that is not consumed is saved, the responsiveness of households to any tax policy (such as those meant to spur aggregate saving and increase the capital stock) will depend on the structure of the consumption function and particularly what it says about how saving responds to interest rates. In the short run, the effectiveness of tax cuts or other income-boosting policies (such as those meant to stimulate a recessionary economy ) will depend on what the consumption function says about how much the typical recipient spends or saves out of the extra income. At the microeconomic level the structure of the consumption function is of interest in itself, but it also has a powerful influence on many other kinds of economic behavior. For example, individuals with only a small stock of savings who are laid off from their jobs may be forced to take new jobs quickly, even if those jobs are a poor match for their skills. On the other hand, laid-off consumers with substantial savings may be able to wait until they can find a better job match. Whether a consumer is likely to have much

savings when laid off will depend on the degree of patience reflected in the consumption function.

Q4. Why does one need to understand Cost Function? Cost Function: The term cost function is a financial term used by economists and managers within businesses to understand how costs behave. The cost function shows how a cost changes as the levels of an activity relating to that cost change. There are three basic types of linear cost functions: fixed, variable, and mixed. In fixed functions, the cost is the same regardless of activity; variable functions change the cost depending on activity; and mixed functions combine the two a cost will be fixed to a certain point, then can change based on related activity. Production theory shows how to determine the least cost method of producing a given output with a specific set of input prices. The production process is a system of transforming inputs into outputs. Production cost is the evolution of this transformation. Obviously, a firm would need to have knowledge of its production cost of various levels of output (cost functions) for managerial planning. A cost output function is a relationship between value of production-inputs that are used by the firm in each period and the corresponding rates of output attained. Cost functions are derived functions. They are derived from the production function, which describe the available efficient methods of production at any one time.