production5.pdf

8/10/2019 production5.pdf

1/35

PRODUCTION ND COST

THEORY


2/35

The Firm:

Production FunctionCost Function

BASIC PRODUCTION

CONCEPTS


3/35

The Firm

Firm

An organization that brings together factors of

productionlabor, land, physical capital,

human capital, and entrepreneurial skilltoproduce a product or service that it hopes can

be sold at a profit


4/35

The Firm

Profit and costs

Accounting profits = total revenues - explicit costs

Explicit Costs

Costs that business managers must take account of because they

must be paid


5/35

The Firm

The goal of the firm: profit maximization

Firms are expected to try to make the

positive difference between total revenuesand total costs as large as they can.


6/35

The Relationship

Between Output and Inputs

Production Function

The relationship between inputs and output

A technological, not an economic, relationship

The relationship between inputs and

maximum physical output


7/35

The Relationship


Production

Any activity that results in the conversion of

resources into products that can be used in

consumption


8/35

PRODUCTIONINPUTS

PRODUCTION

PROCESS

PRODUCTIONOUTPUT

Land

Labor

CapitalRaw Materials

Entrepreneur

Manufacturing

Assembly

ProcessingService

Finished Products

Semi-processed products

Services


9/35

The Relationship


*Q = output/time periodK= capital

L = labor

Q = (K,L)*

or

Output/time period = some function of capital and labor inputs


10/35

Two types of Production Inputs

Fixed Input

Variable Input

Point of comparison Fixed Input Variable Input

Necessity in Production Supplementary; even in

their absence some

amount of productioncan be carried out

Without these factors no

production can be

carried out

Examples Plant, machinery,

manager, land, factorypremises

Labor, raw materials,

transport, frieght


11/35

THE LAW OF DIMINISHING RETURNS

When one of the factors of production is

held fixed in supply, successive additionsof other factors will lead to an increase in

returns up to a point, but beyond this point

returns will diminish


12/35

The Law of Diminishing Returns

NUMBER OF

WORKERS

TOTAL

PHYSICAL

PRODUCT (TPP)

MARGINAL

PHYSICAL

PRODUCT (MPP)

AVERAGE

PHYSICAL

PRODUCT (APP)

1 10 10 10

2 30 30-10=20 15

3 90 90-30=60 30

4 120 120-90=30 30

5 130 130-120=10 26

6 120 120-130=-10 20


13/35

The Relationship


Marginal Physical Product

The physical output that is due to the additionof one more unit of a variable factor of

production The change in total product occurring when a

variable input is increased and all other inputsare held constant

Also called marginal productor marginalreturn


14/35

Diminishing Returns, the Production Function,

and Marginal Product


15/35


and Marginal Product: A Hypothetical Case

Figure 22-2, Panel (b)


16/35

Figure 22-2, Panel (c)


and Marginal Product


17/35

COST & PROFIT CONCEPT

Types of Cost

Variable Cost : are

expenses incurred in

production that tend tochange directly as

production increases

Fixed Cost : are

expenses that do notchange or vary with

production

TC = TFC + TVC

TVC = (VC/u) (u)


18/35

Revenue : sales generatedby an enterprise

TR = (Sp/u) (u)

Profits : difference between thetotal revenue and total cost

TP = TR- TC

TR= TC (Break Even)

TR> TC (Profit)

TC>TR (Losses)


19/35

Cost of Production: An Example

Figure 22-2, Panel (a)


20/35

Costs(dollarperday)

2

4

6

8

12

2 4 6 8 100 1 3 5 7 9 11

16

Output (calculators per day)

10

14

ATC

AVC

AFC



21/35

AFC

AVC

Costs(dollar

perday)


ATC


TP

ATC = AVC + AFC

AFC = ATC - AVC

AVC


22/35

Short-Run Costs to the Firm

Marginal Cost

The change in total costs due to a one-unit

change in production rate

Marginal costs (MC) =

change in total cost

change in output


23/35

TotalTotal Variable Total Marginal

Output Costs Costs Cost(Q/day) (TVC) (TC) (MC)

0 0

1 5

2 8

3 10

4 11

5 13

6 16

7 20

8 25

9 31

10 38

11 46

10

15

18

20

21

23

26

30

35

41

48

56

5

32

1

2

3

45

6

7

8

C

osts(dollarper

day)

2

4

6

8

12

2 4 6 8 100 1 3 5 7 9 11

16


10

14

MC



24/35


1110

AFC

AVC

MC

ATC

9876543210

2

4

6

8

Panel (c)

16

14

12

10

Output (recordable DVDs per day)

Costs(d

ollarsperrecordableDVD)


25/35


26/35

The Relationship Between Diminishing

Marginal Returns and Cost Curves

Labor cost assumed constant

MC =DTC

D

Output

Recall: labor is the variable input

MC =

W

MPP


27/35




28/35

Figure 22-3, Panels (b) and (c)

The Relationship Between

Physical Output and Costs


29/35

The Relationship Between

Physical Output and Costs

Figure 22-3, Panels (c) and (d)


30/35



Firms short-run cost curves are a

reflection of the law of diminishing

marginal returns.

Given any constant price of the variable

input, marginal costs decline as long as

the marginal product of the variable

resource is rising.


31/35



At the point at which diminishing marginal

returns begin, marginal costs begin to rise

as the marginal product of the variable

input begins to decline.


32/35



AVC =TVC

output

AVC =W

AP


33/35

TR = TC

TR =100; TC= 100; TR=TC

TR=100; TC =50, P/L= TR-TC= 100-50= 50Profit

TR=100; TC=200, P/L =TR-TC = 100-200= (100) Breakeven?

P200price shirt; P200,000(machine)); (80/hr labor)

TR= TC

(sp/u) (u)= TFC+TVC 200(x) = 200,000 + 80(x)

200x-80x = 200,000

120x = 200,000

X= 200,000/120 1,667 pairs will have to be sold to break even

< = profit; >=loss


34/35


35/35

The Firm: Cost and Output

Determination

End

production5.pdf

Documents

Transcript of production5.pdf