Production, Cost Analysis & Decision Making

8/8/2019 Production, Cost Analysis & Decision Making

1/28

PRODUCTION, COST ANALYSIS &

DECISION MAKING

Contents :Production:

Hemant Shetty (40) & Kamakhya Narayan (19)

Cost Analysis:

Hetal Desai (10) & Gohil Jayesh (13)

Decision Analysis:

Kuntal Rastogi (33)


2/28

PRODUCTION :

Theory of Firm

- Production technologies

- Cost Constraints

- Input Choices

Factors of Production

Production function

q = F(K,L)


3/28

PRODUCTION: ONE VARIABLE

INPUTWe will begin looking at the short run whenonly one input can be variedW

e assume capital is fixed and labor isvariable

Output can only be increased byincreasing labor

Must know how output changes as theamount of labor is changed


4/28

Production: One Variable

Input Average product of Labor - Output per unit of

a particular product

Measures the productivity of a firms labor interms of how much, on average, each workercan produce

Avg Prod of Labor = output/Labor Input


5/28


Input Marginal Product of Labor additional

output produced when labor increases by one

unit Change in output divided by the change in

labor Marg Prod of Labor = change in output/change in labor input


6/28


Input


7/28

Product Curves

We can show a geometric relationship

between the total product and the average

and marginal product curves Slope of line from origin to any point on the total

product curve is the average product

At point B, AP = 60/3 = 20 which is the same as the

slope of the line from the origin to point B on thetotal product curve


8/28


Input


9/28

Product Curves

Geometric relationship between total

product and marginal product

The marginal product is the slope of the linetangent to any corresponding point on the totalproduct curve

For 2 units of labor, MP = 30/2 = 15 which is slope

of total product curve at point A


10/28

Production: Two Variable

Inputs Firm can produce output by combining

different amounts of labor and capital

In the long run, capital and labor are bothvariable

We can look at the output we can achieve

with different combinations of capital andlabor Table 6.4


11/28


Inputs


12/28


Inputs The information can be represented

graphically using isoquants

Curves showing all possible combinations ofinputs that yield the same output

Curves are smooth to allow for use of

fractional inputs

Curve 1 shows all possible combinations of laborand capital that will produce 55 units of output


13/28


14/28


Inputs As labor increases to replace capital

Labor becomes relatively less productive

Capital becomes relatively more productive Need less capital to keep output constant

Isoquant becomes flatter


15/28

A Production Function for

Wheat Farmers can produce crops with different

combinations of capital and labor

Crops in US are typically grown with capital-intensive technology

Crops in developing countries grown with labor-intensive productions

Can show the different options of cropproduction with isoquants


16/28

A Production Function for

Wheat Manager of a farm can use the isoquant to

decide what combination of labor and capital

will maximize profits from crop production A: 500 hours of labor, 100 units of capital

B: decreases unit of capital to 90, but mustincrease hours of labor by 260 to 760 hours

This experiment shows the farmer the shape ofthe isoquant


17/28

Isoquant Describing the

Production of Wheat

Capital

Labor250 500 760 1000

40

80

120

100

90

A

10-K!(B

260L !(

Point A is more

capital-intensive, and

B is more labor-intensive.


18/28

There are following types of costs:

Classification of costs into

- Direct costs

- Indirect costs

- Finance costs

Types of Costs

1) Opportunity cost

2) Money cost

- Explicit

- Implicit3) Sunk costs

4) Accounting Cost


19/28

Categorisation of costs (important for decision making process)

Fixed costs (also known as Period costs, constant costs)

Variable costs (also known as marginal costs)

semi variable costs (split into Variable & fixed portion)

Incremental costs (can be variable cost and / or fixed costs)


20/28

Relevant costs & irrelevant costs(used for short term decision making)

All variable costs associated to a decision are relevant

All historical costs irrelevant

All existing fixed costs (being sunk costs) irrelevant

All future fixed costs associated to decisionmaking relevant

Opportunity costs (arising due to decisionmaking) relevant


21/28

Cost in Short Run and Long Run How the COST & DECSION can be change

in Short Run and Long Run

How the same costs are Fixed / Variable inshort Run / Long Run

How the Law of Diminishing Marginal

Returns works only in Short run & useful to

Long run Decision


22/28


23/28

PROFIT LOSSES & BREAKEVEN Break Even Analysis

Minimum out put the firm need to produce its costs

TOTAL COST = TOTAL REVENUE

WhereP Price

Q Output in unitsTFC Total fixed cost

AVC Average Variable cost Assumptions:

1. The cost and revenue functions are linear functions.

2. The firm can estimate the cost and revenues in advance.

3. Price remains uniform at all levels of out put.

4.The costs are made up of fixed and variable costs.


24/28

PROFIT LOSSES & BREAKEVENCase 1:

Price is P0 or aFor profit

maximisation

output is y0( refer the intersection

point of MC )

ATC (Average Total

Cost) is b

Profit per unit would be ab

and the TOTAL PROFIT would be the total area

marked with dotted lines


25/28


Price is P1 or c(Point touching the

ATC curve)

Optimal output is y1

(refer the intersectionpoint of MC )

ATC (Average Total Cost)

is C

Profit per unit would be ZERO

And the firm is at BREAK EVEN


26/28


Price is P2 or d(Point touching the

ATC curve)

Optimal output is y2

(refer the intersectionpoint of MC )

ATC (Average Total Cost)

is e

Loss per unit would be ed

And the TOTAL LOSSES would be the total area

marked

d


27/28


Price is P3 or f(i.e. min point of AVC)

output is y3( refer the intersection

point of MC )

And P3 = AVC

Total Loss=Total Cost Total Revenue

= (TFC + TVC) TR

= TFC + AVC*y3 - p3*y3= TFC (as P3 = AVC)


28/28

PROFIT LOSSES & BREAKEVENContd..

Case 5:

Price falls below P3 orf output is less than y3(i.e. doesnot touch min point (refer the intersection point

of AVC) of MC )

i.e. If p3 < Min AVC (market price is less than Min AVC)

Total Loss=Total Cost Total Revenue

= (TFC + TVC) TR

= TFC + AVC*y3 - p3*y3= TFC + (AVC - p3)*y3

Then the losses would start exceeding the TFC ,

Hence reaches to SHUT DOWN CONDITION

Production, Cost Analysis & Decision Making

Documents

Transcript of Production, Cost Analysis & Decision Making