Production
and Cost
Production
Economic activity, which combines the
four factors of production to form
output that will give direct satisfaction
to consumers.
It includes material goods or any
services.
Is the process of converting inputs into
outputs.
Inputs
Commodities and services that
are used to produce goods and
services.
Generally classified into three
broad categories:
Land
Labor
Capital
Labor Intensive
Philippines
Vietnam
China
Other developing countries
Capital Intensive
Germany
Japan
Korea
United States of America
Production Function
Functional relationship between
quantities of inputs used in production
and outputs to be produced.
Specifies the maximum output that
can be produced with a given quantity
of inputs.
MP=
MP=
AP=
Input
(Labor)e
Hypothetical Production
Schedule of T-shirts
TL
MP
AP
20
12
10
37
17
12
57
20
14
72
15
14
80
13
85
12
88
11
86
-2
10
10
82
-4
80
60
TP
MP
40
AP
20
0
0
10
-20
It shows that the total product increases at a decreasing rate while marginal and average
products first increases, reach their maximum and thereafter decline.
For example:
When more sewers are added to sew t-shirts using a
single sewing machine, the sewing machine gets more
crowded so that the marginal product of the additional
sewer declines.
In fact, in our example the 10th sewer added
contributes less than all the other sewers since his
marginal product is negative 4 units of t-shirts.
For example:
If you as manager of a garments factory employ
just on worker, that person that you have employed
must learn all the aspects on making a t-shirt, cutting
the cloth, making the pattern, sewing the cloth,
putting the buttons, ironing the shirt, packaging,
delivering, etc. That single person must perform all
these tasks.
If you hire a second person, the two workers you
have can now specialize in different aspects of the
production process. As results two marginal product of
the second worker is greater than the marginal product
of the first worker. In this case marginal product is
increasing. Most production processes experience
increasing marginal returns initially.
For example:
If you hire the fifth worker, output
increases( MP=15) but not as much as it did
when you hired your fourth worker (MP=20).
In this case the first four workers exhaust
all the possible gains from specialization
and the division of labor. By hiring the
fifth worker, he produces more t-shirts, but
the sewing machine is being operated
closer to its limits. Sometimes the fifth
worker has nothing to do because the
machine is utilized by the other workers.
Return to Scale
Diminishing returns (also called law of
diminishing returns) states that in all
productive processes, adding more of one factor
of production, while holding all others
constant ("ceteris paribus"), will at some point
yield lower incremental per-unit returns, and
marginal products refer to the response of
output to an increase of a single input when all
other inputs are held constant.
For example:
In year one a firm employs 200
workers, uses 50 machines, and produces
1,000 products. In year two it employs
400 workers, uses 100 machines (inputs
doubled), and produces 2,500 products
(output more than doubled).
For example:
In year one, a firm employs 200
workers, uses 50 machines, and produces
1,000 products. In year two it employs
400 workers, uses 100 machines (inputs
doubled), and produces 1,500 products
(output less than doubled).
Problem:
In the example above, after doubling
the inputs in year one, what would
output have to be in year two for the
firm to experience constant returns to
scale?
Solution:
2,000 products. At 2,000 products,
the output doubles. Because the
inputs double, the increase in
production is proportionate. By
definition, this equates to constant
returns to scale
Theory of Cost
Cost refers to all expenses acquired
during the economic activity or the
production of goods and services. It
includes expenditures incurred for the
utilization of the various factors of
production in the creation of goods.
Economic Objectives
market share
profit margin
return on investment
technological advancement
customer satisfaction
shareholder value
Noneconomic Objectives
workplace environment
product quality
service to community
Opportunity Cost
The value of most appealing
alternative that is not chosen is called
opportunity cost.
Opportunities:
-To work all day and makes
money
-To take the day off and to go to
a movie
Economic Profit
Fixed Cost
Fixed cost overhead or supplementary cost
are those expenses which are spent for the
use of fixed factors of production.
Fixed costs stay the same no matter how
much output changes.
Fixed cost are sometimes call sunk costs
because once we have obligated ourselves to
pay them, that money has been sunk into
our business firm. Fixed costs are the
firms overhead.
Examples:
Rent, interest, and expenses on
machines, depreciation, and
salary/wages of employees under
guaranteed contract. These expenses
do not change regardless of a change
in quantity of output produced.
Variable Cost
Variable costs or prime or operating costs,
on the other hand, are those expenses which
change as a consequences of a change in
quantity of output produced.
Variable costs are those costs which are
incurred on variable costs are those costs
which are incurred on variable factor inputs.
These include expenses on labor inputs, raw
materials, electricity, fuel etc,.
Examples:
TC = TFC + TVC
The figure illustrates the relationship of total cost to total variable cost and total fixed cost.
The figure show s the relationship of marginal cost to average fixed cost, average
variable cost, and average total cost.
Examples:
Table in Short run cost
at output 0 there is a FC (100) therefore is a TC of
100
Why can a firm not go out of the business in the short
run?
-Because it still has FIXED COST.
Summary:
Firm will operate in the short run when:
Total Revenue EXCEEDS Variable
Cost
Firm will shut down in the short run
when:
Total Revenue is LESS THAN Variable
Cost