# Production Cost _ Boundless Economics.pdf - 3/20/2019...

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Unformatted text preview: 3/20/2019 Production Cost | Boundless Economics Tpes of Costs Variale costs change according to the quantit of goods produced; xed costs are independent of the quantit of goods eing produced. LARNING OJCTIV Di erentiate xed costs and variale costs KY TAKAWAY Ke Points Total cost is the sum of xed and variale costs. Variale costs change according to the quantit of a good or service eing produced. The amount of materials and laor that is needed for to make a good increases in direct proportion to the numer of goods produced. The cost “varies” according to production. Fixed costs are independent of the qualit of goods or services produced. Fixed costs (also referred to as overhead costs) tend to e time related costs including salaries or monthl rental fees. Fixed costs are onl short term and do change over time. The long run is su cient time of all short-run inputs that are xed to ecome variale. Ke Terms xed cost: usiness expenses that are not dependent on the level of goods or services produced the usiness. 2/15 3/20/2019 Production Cost | Boundless Economics variale cost: A cost that changes with the change in volume of activit of an organization. Total Cost In economics, the total cost (TC) is the total economic cost of production. It consists of variale costs and xed costs. Total cost is the total opportunit cost of each factor of production as part of its xed or variale costs. Total Costs \$ Variable Costs Fixed Costs Units Calculating total cost: This graphs shows the relationship etween xed cost and variale cost. The sum of the two equal the total cost. Variale Costs Variale cost (VC) changes according to the quantit of a good or service eing produced. It includes inputs like laor and raw materials. Variale costs are also the sum of marginal costs over all of the units produced (referred to as normal costs). For example, in the case of a clothing manufacturer, the variale costs would e the cost of the direct material (cloth) and the direct laor. The amount of materials and laor that is needed for each shirt increases in direct proportion to the numer of shirts produced. The cost “varies” according to production. Fixed Costs 3/15 3/20/2019 Production Cost | Boundless Economics Fixed costs (FC) are incurred independent of the qualit of goods or services produced. The include inputs (capital) that cannot e adjusted in the short term, such as uildings and machiner. Fixed costs (also referred to as overhead costs) tend to e time related costs, including salaries or monthl rental fees. An example of a xed cost would e the cost of renting a warehouse for a speci c lease period. However, xed costs are not permanent. The are onl xed in relation to the quantit of production for a certain time period. In the long run, the cost of all inputs is variale. conomic Cost The economic cost of a decision that a rm makes depends on the cost of the alternative chosen and the ene t that the est alternative would have provided if chosen. conomic cost is the sum of all the variale and xed costs (also called accounting cost) plus opportunit costs. Average and Marginal Cost Marginal cost is the change in total cost when another unit is produced; average cost is the total cost divided the numer of goods produced. LARNING OJCTIV Distinguish etween marginal and average costs KY TAKAWAY Ke Points The marginal cost is the cost of producing one more unit of a good. Marginal cost includes all of the costs that var with the level of production. For example, if a compan needs to 4/15 3/20/2019 Production Cost | Boundless Economics uild a new factor in order to produce more goods, the cost of uilding the factor is a marginal cost. conomists analze oth short run and long run average cost. hort run average costs var in relation to the quantit of goods eing produced. Long run average cost includes the variation of quantities used for all inputs necessar for production. When the average cost declines, the marginal cost is less than the average cost. When the average cost increases, the marginal cost is greater than the average cost. When the average cost stas the same (is at a minimum or maximum), the marginal cost equals the average cost. Ke Terms marginal cost: The increase in cost that accompanies a unit increase in output; the partial derivative of the cost function with respect to output. Additional cost associated with producing one more unit of output. average cost: In economics, average cost or unit cost is equal to total cost divided the numer of goods produced. Marginal Cost In economics, marginal cost is the change in the total cost when the quantit produced changes one unit. It is the cost of producing one more unit of a good. Marginal cost includes all of the costs that var with the level of production. For example, if a compan needs to uild a new factor in order to produce more goods, the cost of uilding the factor is a marginal cost. The amount of marginal cost varies according to the volume of the good eing produced. conomic factors that impact the marginal cost include information asmmetries, positive and negative externalities, transaction costs, and price discrimination. Marginal cost is not related to xed costs. An example of calculating marginal cost is: the production of one pair of shoes is \$30. The total cost for making two 5/15 3/20/2019 Production Cost | Boundless Economics pairs of shoes is \$40. The marginal cost of producing the second pair of shoes is \$10. Average Cost The average cost is the total cost divided the numer of goods produced. It is also equal to the sum of average variale costs and average xed costs. Average cost can e in uenced the time period for production (increasing production ma e expensive or impossile in the short run). Average costs are the driving factor of suppl and demand within a market. conomists analze oth short run and long run average cost. hort run average costs var in relation to the quantit of goods eing produced. Long run average cost includes the variation of quantities used for all inputs necessar for production. Relationship etween Average and Marginal Cost Average cost and marginal cost impact one another as production uctuate: Price MC ATC MR Quantity Cost curve: This graph is a cost curve that shows the average total cost, marginal cost, and marginal revenue. The curves show how each cost changes with an increase in product price and quantit produced. 6/15 3/20/2019 Production Cost | Boundless Economics When the average cost declines, the marginal cost is less than the average cost. When the average cost increases, the marginal cost is greater than the average cost. When the average cost stas the same (is at a minimum or maximum), the marginal cost equals the average cost. hort Run and Long Run Costs Long run costs have no xed factors of production, while short run costs have xed factors and variales that impact production. LARNING OJCTIV xplain the di erences etween short and long run costs KY TAKAWAY Ke Points In the short run, there are oth xed and variale costs. In the long run, there are no xed costs. cient long run costs are sustained when the comination of outputs that a rm produces results in the desired quantit of the goods at the lowest possile cost. Variale costs change with the output. xamples of variale costs include emploee wages and costs of raw materials. The short run costs increase or decrease ased on variale cost as well as the rate of production. If a rm manages its short run costs well over time, it will e more 7/15 3/20/2019 Production Cost | Boundless Economics likel to succeed in reaching the desired long run costs and goals. Ke Terms variale cost: A cost that changes with the change in volume of activit of an organization. xed cost: usiness expenses that are not dependent on the level of goods or services produced the usiness. In economics, “short run” and “long run” are not roadl de ned as a rest of time. Rather, the are unique to each rm. Long Run Costs Long run costs are accumulated when rms change production levels over time in response to expected economic pro ts or losses. In the long run there are no xed factors of production. The land, laor, capital goods, and entrepreneurship all var to reach the the long run cost of producing a good or service. The long run is a planning and implementation stage for producers. The analze the current and projected state of the market in order to make production decisions. cient long run costs are sustained when the comination of outputs that a rm produces results in the desired quantit of the goods at the lowest possile cost. xamples of long run decisions that impact a rm’s costs include changing the quantit of production, decreasing or expanding a compan, and entering or leaving a market. hort Run Costs hort run costs are accumulated in real time throughout the production process. Fixed costs have no impact of short run costs, onl variale costs and revenues a ect the short run production. Variale costs change with the output. xamples of variale costs include emploee wages and costs of raw materials. The short run costs increase or decrease ased on variale cost as well as the rate of production. If a 8/15 3/20/2019 Production Cost | Boundless Economics rm manages its short run costs well over time, it will e more likel to succeed in reaching the desired long run costs and goals. Di erences The main di erence etween long run and short run costs is that there are no xed factors in the long run; there are oth xed and variale factors in the short run. In the long run the general price level, contractual wages, and expectations adjust full to the state of the econom. In the short run these variales do not alwas adjust due to the condensed time period. In order to e successful a rm must set realistic long run cost expectations. How the short run costs are handled determines whether the rm will meet its future production and nancial goals. STC TC LTC rK1 0 Q Cost curve: This graph shows the relationship etween long run and short run costs. conomies and Diseconomies of cale Increasing, constant, and diminishing returns to scale descrie how quickl output rises as inputs increase. 9/15 3/20/2019 Production Cost | Boundless Economics LARNING OJCTIV Identif the three tpes of returns to scale and descrie how the occur KY TAKAWAY Ke Points In economics, returns to scale descries what happens when the scale of production increases over the long run when all input levels are variale (chosen the rm ). Increasing returns to scale (IR) refers to a production process where an increase in the numer of units produced causes a decrease in the average cost of each unit. Constant returns to scale (CR) refers to a production process where an increase in the numer of units produced causes no change in the average cost of each unit. Diminishing returns to scale (DR) refers to production where the costs for production do not decrease as a result of increased production. The DR is the opposite of the IR. Ke Terms return to scale: A term referring to changes in output resulting from a proportional change in all inputs (where all inputs increase a constant factor). average cost: In economics, average cost or unit cost is equal to total cost divided the numer of goods produced. 10/15 3/20/2019 Production Cost | Boundless Economics In economics, returns to scale descries what happens when the scale of production increases over the long run when all input levels are variale (chosen the rm). Returns to scale explains how the rate of increase in production is related to the increase in inputs in the long run. There are three stages in the returns to scale: increasing returns to scale (IR), constant returns to scale (CR), and diminishing returns to scale (DR). Returns to scale var etween industries, ut tpicall a rm will have increasing returns to scale at low levels of production, decreasing returns to scale at high levels of production, and constant returns to scale at some point in the middle. Long Run ATC Curves: This graph shows that as the output (production) increases, long run average total cost curve decreases in economies of scale, constant in constant returns to scale, and increases in diseconomies of scale. Increasing Returns to cale The rst stage, increasing returns to scale (IR) refers to a production process where an increase in the numer of units produced causes a decrease in the average cost of each unit. In other words, a rm is experiencing IR when the cost of producing an additional unit of output decreases as the volume of its production increases. IR ma take place, for example, if the cost of production of a manufactured good would 11/15 3/20/2019 Production Cost | Boundless Economics decrease with the increase in quantit produced due to the production materials eing otained at a cheaper price. Constant Return to cale The second stage, constant returns to scale (CR) refers to a production process where an increase in the numer of units produced causes no change in the average cost of each unit. If output changes proportionall with all the inputs, then there are constant returns to scale. Diminishing Return to cale The nal stage, diminishing returns to scale (DR) refers to production for which the average costs of output increase as the level of production increases. The DR is the opposite of the IR. DR might occur if, for example, a furniture compan was forced to import wood from further and further awa as its operations increased. conomic Costs The economic cost is ased on the cost of the alternative chosen and the ene t that the est alternative would have provided if chosen. LARNING OJCTIV reak down the components of a rm’s economic costs KY TAKAWAY Ke Points conomic cost takes into account costs attriuted to the alternative chosen and costs speci c to the forgone opportunit. 12/15 3/20/2019 Production Cost | Boundless Economics Components of economic cost include total cost, variale cost, xed cost, average cost, and marginal cost. Cost curves – a graph of the costs of production as a function of total quantit produced. In a free market econom, rms use cost curves to nd the optimal point of production (to minimize cost). Maximizing rms use the curves to decide output quantities to achieve production goals. Average cost (AC) – total costs divided output (AC = TFC/q + TVC/q). Marginal cost (MC) – the change in the total cost when the quantit produced changes one unit. Cost curves – a graph of the costs of production as a function of total quantit produced. In a free market econom, rms use cost curves to nd the optimal point of production (to minimize cost). Maximizing rms use the curves to decide output quantities to achieve production goals. Ke Terms economic cost: The accounting cost plus opportunit cost. cost: A negative consequence or loss that occurs or is required to occur. Opportunit cost: The cost of an activit measured in terms of the value of the next est alternative forgone (that is not chosen). conomic Cost Throughout the production of a good or service, a rm must make decisions ased on economic cost. The economic cost of a decision is ased on oth the cost of the alternative chosen and the ene t that the est alternative would have provided if chosen. conomic cost includes opportunit cost when analzing economic decisions. 13/15 3/20/2019 Production Cost | Boundless Economics An example of economic cost would e the cost of attending college. The accounting cost includes all charges such as tuition, ooks, food, housing, and other expenditures. The opportunit cost includes the salar or wage the individual could e earning if he was emploed during his college ears instead of eing in school. o, the economic cost of college is the accounting cost plus the opportunit cost. Components of conomic Costs conomic cost takes into account costs attriuted to the alternative chosen and costs speci c to the forgone opportunit. efore making economic decisions, there are a series of components of economic costs that a rm will take into consideration. These components include: Total cost (TC): total cost equals total xed cost plus total variale costs (TC = TFC + TVC). Variale cost (VC): the cost paid to the variale input. Inputs include laor, capital, materials, power, land, and uildings. Variale input is traditionall assumed to e laor. Total variale cost (TVC): same as variale costs. Fixed cost (FC): the costs of the xed assets (those that do not var with production). Total xed cost (TFC): same as xed cost. Average cost (AC): total costs divided output (AC = TFC/q + TVC/q). Average xed cost (AFC): the xed costs divided output (AFC = TFC/q). The average xed cost function continuousl declines as production increases. Average variale cost (AVC): variale costs divided output (AVC = TVC/q). The average variale cost curve is normall U-shaped. It lies elow the average cost curve, starting to the right of the axis. Marginal cost (MC): the change in the total cost when the quantit produced changes one unit. 14/15 3/20/2019 Production Cost | Boundless Economics Cost curves: a graph of the costs of production as a function of total quantit produced. In a free market econom, rms use cost curves to nd the optimal point of production (to minimize cost). Maximizing rms use the curves to decide output quantities to achieve production goals. Previous Next 15/15 ...
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