Bab6 production and porduction cost
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Production And Cost of Production
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Production
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Introduction– We will focus on supply in this chapter. We will
analyze how the factors of production are combined in a firm to produce goods and services.
Definition – Production means the process of using the factors
of production to produce goods or services– Also can be stated as, ‘Transformation of inputs
into outputs’
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• Factors of production Land Labour Capital Entrepeneurship
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• Production functionThe functional relationship between inputs(factors of
production) and outputs ( goods and services)It is able to show maximum output that can be produce with
the given inputsIt can be represented in the form of a mathematical equation
such as :
Where Q is amount of output per unit of timeK,L,M,etc. are the various factors of production like capital,
labour, raw material, etc.Production function can be represented in the form of a table,
equation or graph
Q = f(K,L,M,etc.)
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Short-run and Long Run Production function
Short run and Long Run depend on the inputs, which can be varied in production
There are two type of factor inputs :
fixed input - an input in which the quantity does not change according to output. Fro example, machinery, land, buildings, tools, equipment, etc.
Variable input – an input in which the quantity changes according to output. For example, raw materials, electricity, fuel, transportation, communication, etc.
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The short run period is the time frame which at least of the inputs (factors of production) is fixed but the other inouts are varied
Example,
The long run period is the time frame in which all inout are variable. In the long run firms can alter the inputs to increase the output.
Example
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Law of Diminishing Marginal Returns This law explain the behaviour of production functions in
the short run. The law states that if quantities of certain factors are
increased while the quantities of one or more factors are held constant, beyond of certain level of production, the rate of increase in output will decrease (total pruduction wil increase in decreasing rate) and eventually the marginal product declines
The law also known as the law of variable proportions because it show how output varies when the proportion of a variable input to fixed input used in production varies.
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Total Product (TP) -- It is the amount of output when given amount of that input is used together with fixed input
Average Product (AP) -- It can be obtained by dividing the total product by the amount of that input used. In this case labour is used.
Average Product (APL) = Total Production Total Labour
Average Product (APK) = Total Production Total Capital
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Marginal Product (MP) – It is the change in the total product of that input corresponding to an addition or unit change in its labour. Marginal product is the additional to total product when one more unit of labour is employed.
Marginal Product (MPL) = Change in Total Product Change in Labour
MPL = ∆TP ∆L
Marginal Product (MPK) = Change in Total Product Change in Capital
MPK = ∆TP ∆K
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• Jadual
Capital(fixed input)
Labour(Variable input)
Total Product
Marginal Product
Average Product
Stage of Product
10 0 0 0 0
STAGE 110 1 8 8 8
10 2 20 12 10
10 3 33 13 11
10 4 44 11 11
10 5 50 6 10STAGE 210 6 54 4 9
10 7 56 2 8
10 8 56 0 7STAGE 310 9 54 -2 6
10 10 50 -4 5
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Unit of Variable Factor (labour)
TP/ AP/ MP
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Relationship between Total Product(TP) and Marginal Product(MP)• When MP is increasing, TP will increase at an increasing rate.• When MP is decreasing, TP will increase at a decreasing rate• When MP is zero, TP is at Maximum.• When MP is negative, TP declines
Relationship between Marginal Product(MP) and Average Product (AP)• When MP is above AP, AP is increasing• When MP equals to AP, AP is at maximum.• When MP below to AP, AP is decreasing.
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Stages of Production• Stage 1: Increasing returns• Stage 2: Diminishing Returns• Stage 3: Negative Returns
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• Isoquant Analysis– The term isoquant bas been derived from “iso” which
means equal, and “Quant” meaning quantity .– An isoquant represent all the possible combinations of
variable input that are used to generate the same level of output (total product).
– The isoquant analysis illustrates that there are various ways to generate a given quantity of output in one period of time
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• Let us take the example of a firm roducing soymilk that used the input of labour and capital.
• Table 6.4 below lists the output that the firm can produce with various combinations of input.
Capital LABOUR
1 2 3 4 5
1 250 450 600 700 800
2 450 650 800 900 950
3 550 800 950 1050 1100
4 700 900 1050 1150 1200
5 800 950 1100 1200 1250
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Labour
Capital (Machine)
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The properties of isoquant are :1. Isoquant curve slopes downward from left to
right2. Isoquant curve is convex to origin3. An isoquant far away from the origin
represents a larger output4. Isoquant curve never intersect with each
other
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Isoquant Map• An isoquant map is a number of isoquants that combined in a
single graph• The isoquant map can be used to estimates the maximum
attainable output from different combinations of inputs.• Figure 6.6 show four different isoquants based on data from
Table 6.3Machine
Labour
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• A firm has two options of producing maximum output. The first option is that a firm can using 1 machine and 5 labours as shown in point A, Another option is by using 5 machines and 1 labour as shown in point D
• All the points on this isoquant curve represent the input combinations that can produce 800 can of soy milk per month
• A higher isoquant curve represent a higher level of output
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• Marginal Rae of Technical Substitution
MRTS = - Change in Capital Change in Labour
= - ∆K ∆L
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Long Run Production Function
– In the long run, all factors including plants and machinery are variable. A firm can expand its scale of productivity by increasing all inputs such as more labour, more equipment, more buildings, etc.
– The law of returns to scale applies in the long run– The law refers to the effects of changes in the scale of
production– The responsiveness of output to a given proportionate change
in quantities of all inputs is called returns to scale– We will look into how proportion output changes when there
is some proportionate change in the amount of all inputs.
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There are three possibilities1. Increasing Returns to Scale -
Quantity of all inputs < Outputs double (labour and capital) doubles
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2. Constant Returns to Scale
Quantity of all inputs = Output doubles (labour and capital) doubles
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3. Decreasing return to Scale
Quantity of all inputs > Outputs double (labour and capital) doubles
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Cost of Production
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Introduction• In this chapter, we will explain the relationship between
costs and output• We will also define the cost of production, identify various
types of costs and analyze short-run costs and long run costs.
Cost concepts• Cost of production refers to the expenses incurred by the
producer in producing a particular quantity of output. • There are different concepts of cost such as implicit and
explicit costs, opportunity costs and social costs
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o Implicit Cost and Explicit Cost
Implicit costs – the value of input service that are used in production which are nor purchased in the market.
It is the value self owned, self employed resources utilized in production
Implicit is included in economic cost but excluded in accounting costs
Example of implicit costs would be the opporturnity cost of the owner’s wife providing (labour) service in production, a self-owned factory and the interest saved because the capital is one’s own.
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Explicit Cost - the value of resources purchased for production.
Explicit both included in both economic and accounting costs Examples of explicit cost are wages and salaries to workers,
payment for fuel, transportation, electricity and power and expenditure in machinery and equipment
Therefore economic cost, which included both implicit and explicit cost, is higher than accounting cost.
ACCOUNTING COST < EONOMIC COST
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o Opportunity Cost The value of the next best use of a resource. In other words, opportunity costs of a particular oroduct is
the value of the forgone alternative product.
o Social Cost The total cost of production of a product and includes direct
ad indirect costs incurred by society Examples of social costs are water pollution from industrial
waste contaminating rivers, and air pollution from mining activities, factory smoke and exhaust fumes from a lare number of vehicles.
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o Sunk Cost The cost that a firm cannot recover from the expenditure it
has been made is called as sunk costs. Only counted in accounting costs and not in economic costs Example, a firm purchased specialized machinery for the
purpose of production. The equipment that firm purchased was design only to do specific work with no alternative use. Then the purchase of such equipment is sunk cost for a firm because it has no alternative use and has zero opportunity costs
Therefore, sunk cos not included in economic cost because it has no opportunity costs
IN conclusion, sunk cost is irrelevant to firm when making future economic decisions.
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Cost Curves in the Short Run• Total Fixed cost• Total Variable Cost
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• Total Cost
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• Graf
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• Avaraged fixed Cost
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• Average Variable Cost
• Averaged Total Cost
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• Marginal Cost
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• Short run Average Total Cost Curve• Graf
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• Stage I• Stage II• Stage III
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• Relationship between Productivity Curve and Cost Curve
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• The cost minimizing Technique
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• Cost curves in the long Run
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• Relationship between Avarage Total Cost (ATC) and Marginal Costs (MC)
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• Graph
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The isocosts Analysis
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Isocost Map
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• Cost minimizing technique
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Graph
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• Explanation of graph
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• Cost Curves in the Long Run
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• Economies of Scales
Internal economies of scales 1 Labour economies 2 Managerial Economies 3Marketing Economies 4 Technical Economies 5 Financial Economies 6 Risk bearing Economies 7 Transport and Storage Economies
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• External Economies of Scale 1 Economies of government action 2 Economies of Concentration 3 Economies of Information 4 Economies of Marketing
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• Diseconomies of Scale• Internal Diseconomies of scale 1 Labor diseconomies 2 Management economies 3 Technical Difficulties
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• External diseconomies of scale 1 Scarcity of raw material 2 Wage Differential 3 Concentration Problems
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• Economies and diseconomies of scope
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Concept of RevenueTotal Revenue (TR)
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• Average Revenue
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• Marginal Revenue
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Relationship between Price, Average Revenue and Marginal Revenue In Perfect Market
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Graph
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• In an Imperfect Market
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• Graf
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