chapter 4 THE ECONOMICS OF FIRMS IN THE MARKET: COST & PRODUCTION …
THE ECONOMICS OF FIRMS IN THE MARKET: COST & PRODUCTION THEORY
What is mean by cost of production?
Cost of production is the total price paid for resources used to manufacture a product or create a service to sell to consumers.
For examples including raw materials, labor, and overhead.
Short run in production cost
Definition: The Short-run Cost is the cost which has short-term implications in the production process, i.e. these are used over a short range of output.
These are the cost incurred once and cannot be used again and again, such as payment of wages, cost of raw materials, etc
Costs in the Short Run
Variable cost is a cost that depends on the level of production chosen.
Fixed cost is any cost that does not depend on the firm’s level of output. These costs are incurred even if the firm is producing nothing. There are no fixed costs in the long run.
Total Cost = Total Fixed cost + Total Variable cost
Total Fixed Cost (TFC)
or overhead refers to the total of all costs that do not change with output, even if output is zero.
Another name for fixed costs in the short run is sunk costs is because firms have no choice but to pay for them
Average fixed cost (AFC)
is the total fixed cost (TFC) divided by the number of units of output (q):
Short-Run Fixed Cost
As output increases, total fixed cost remains constant and average fixed cost declines
shows the relationship between total variable cost and the level of a firm’s output.
derived from production requirements and input prices.
Marginal Cost (MC)
the increase in total cost that results from producing one more unit of output. Marginal cost reflects changes in variable costs.
The Shape of the Marginal Cost Curve in the Short Run
In the short run every firm is constrained by some fixed input that
leads to diminishing returns to variable inputs
limits its capacity to produce.
Average Variable Cost
the total variable cost divided by the number of units of output
Marginal cost is the cost of one additional unit, while average variable cost is the variable cost per unit of all the units being produced
Adding the same amount of total fixed cost to every level of total variable cost yields total cost.
Average Total Cost
total cost divided by the number of units of output (q).
Because AFC falls with output, an ever-declining amount is added to AVC
The Relationship Between Average Total Cost and Marginal Cost
If MC is below ATC, then ATC will decline toward marginal cost
If MC is above ATC, ATC will increase
MC intersects the ATC and AVC curves at their minimum points.
Output Decision : revenues, cost and profit maximaization
The perfectly competitive firm faces a perfectly elastic demand curve for its product
Total Revenue (TR) and Marginal Revenue (MR)
Total revenue (TR) is the total amount that a firm takes in from the sale of its output.
Marginal revenue (MR) is the additional revenue that a firm takes in when it increases output by one additional unit.
Comparing Costs and Revenues to Maximize Profit
The profit-maximizing level of output for all firms is the output level where MR = MC
In perfect competition, MR = P, therefore, the firm will produce up to the point where the price of its output is just equal to short-run marginal cost.
Long run in production cost
Period of time long enough for firms to change the quantities of all resources employed including capital and new factories.
In the long run, an industry and the individual firms it comprises can undertake all desired resource adjustments or in other words, they can change the amount of all inputs used
Economic of scale
A firm achieves economies of scale when it is able to decrease the per unit cost of production (ATC) as output increases.
As plant size increases, more workers are hired and labor becomes increasingly specialized. workers work fewer and fewer tasks and thus become more skilled at those tasks, and production is efficient
As a firm grows, there is greater potential for managers to specialize in particular tasks (e.g. marketing, human resource management, finance
Specialist managers are likely to be more efficient as they possess a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these roles.
Firms might be able to lower average costs by improving the management structure within the firm. The firm might hire better skilled or more experienced managers.
Occur when larger firms are able to lower the unit cost of advertising and promotion perhaps through access to more effective marketing media
Efficient Capital: larger plants can afford better, more efficient equipment
Other: advertising costs fall per unit of output as more units are produced and sold. Production and marketing skills increase as the firm produces and sells more output
larger plants can afford better, more efficient equipment
A technological advancement might drastically change the production process.
For instance, fracking completely changed the oil industry a few years ago.
only large oil firms that could afford to invest in expensive fracking equipment could take advantage of the new technology.
External Economies of Scal
Transportation and Communication
Facility of Workshop
. Research and Experiment
Diseconomies of Scale
The forces which ultimately limit the expansion of industry are the external diseconomies of the scale. These are the result of external forces.
As the industry expands, this factor arises. The reason is the increase in factor price
Sources of Diseconomies of Scale