chp 6 cost of production

8/14/2019 Chp 6 Cost of Production

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Chapter Six

Cost of Production


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Factors

Fixed FactorVariable Factor

Time Factor


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Variable Factor

Factors which increase or decrease with theoutput level of good produced.

Example: Raw material, LaborIt increases with the level of outputincreases. When there is no good producedthere is no usage of variable factor.


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Time factor

Short-runLong-run


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Short-Run Production Relationship

Labor-Output relationshipGiven fixed plant capacity

Total Product (TP): Total Quantity or output of aparticular product.

Marginal Product (MP): Additional Output associatedto adding additional input.

MP = Changes in TP / Changes in Labor input


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Marginal Product (MP): Additional Outputassociated to adding additional input.

MP = Changes in TP / Changes in Labor input

Average Product (AP): labor productivity, output

per unit of labor inputAP = TP / Units of Labor


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(1)Units of

labor

(2)TP

MP, Changes in(2) / Changes in

(1)

AP,(2)/(1)

0 0 -- --

1 10 10 10

2 25 15 12.5

3 45 20 15

4 60 15 15

5 70 10 14

6 75 5 12.5

7 75 0 10.71

IncreasingMarginalReturns

DiminishingMarginalReturns


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Law of Diminishing Returns

Assume Technology is fixed. Techniques of production do not change. All units of labor are of equal quality.

It refers to how the marginal contribution of a factorof production usually decreases as more of the factoris used

Each additional unit of the variable input (Labor)yields smaller and smaller increases in output.First labor employed gives more productivity ascompared to next last.


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Law of Diminishing Returns

When workers cause more congestions thenmarginal productivity would becomenegative.


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TP

Quantity of Labor

TotalProducts


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TP

Quantity of Labor

TotalProducts

Quantity of Labor / marginal andaverage products

Marginal product

AP

MP

IncreasingMarginalReturns

Diminishing MarginalReturn

NegativeMarginalReturn

Relationship between MP and AP:

When MP exceeds AP, AP rises, whenMP is less than AP, then AP declines.


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Short-Run Production Cost:

Fixed costVariable Cost

Total Cost (FC+VC)Variable cost can be controlled or altered inshort run but not Fixed cost.


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Per Unit or Average cost;Average Fixed Cost

AFC = Total Fixed Cost (TFC) / Q

Average Variable CostAVC = Total Variable Cost (TVC) / Q


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ATC

AVC

AFC

AFC


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At low level of output, production isrelatively inefficient

ATC = AVC + AFC

Marginal Cost (MC):

MC = change in TC / change in Q


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Minimum Efficient Scale (MES)

Which is lowest level of output at which afirm can minimize its long-term averagecost.Given demand curve efficient production willbe achieved with large scale producer. Smallscale firms can not realize minimum efficientscale.

Natural monopoly: average total cost isminimized when only one firm producesparticular goods and services


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Applications


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Rising cost of Insurance companies

9/11 terrorist attackIncrease cost of security and cameras

Increase premiums of insurance


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Successful Start-Up Firms

These firms reduce their cost by moving highto low point on their short-run cost

Their ability to spread huge productdevelopment and advertising cost over largenumber of goods.


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Daily Newspaper

Resources to produce newspaper: reporters,delivery people, photographers, editors,management, printing press, ink makers,loggers, loggers truck delivery, and so on.Yet sell for $0.50 per newspapers.They are achieving economies of scale.


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The End

chp 6 cost of production

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