Bbi1114 notes 1475227966 chapter 6 prodc

BECON 1201/ BBI 1113/ BBI 1114 •
Microeconomics

LECTURE 6 PRODUCTION &
COST
Costs & Output Decisions
Faculty of Business Management & Globalization
Tel : 603 8317 8833 (Ext 8407)


Objectives
•

In this chapter, we will focus on the
relationship between a firm’s technology and
its production costs.
BECON 1201/ BBI 1113/ BBI 1114

Students will able to:

1. To describe the production
function.
2. Understand law of
diminishing returns.
3. Understand economies
and diseconomies of scale,
short run & long run.
 We will analyze how
factors of production are
combine to produce goods
& services.

Microeconomics


WHAT ARE COSTS?
• According to the Law of Supply:
Supply
– Firms are willing to produce & sell a
greater quantity of a good when the price
is high.
– This results in upward slopping supply
curve.
• The Firm’s Objective
- The economic goal of the firm is to
maximize profits.
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Microeconomics


DEFINATION OF PRODUCTION
“Production means the process of using the
factors of production to produce G&S.”

“transformation of
inputs into outputs”

Production

inputs things that a firm buys for use in

prod, e.g land, labour, capital &
entrepreneur.
outputs = what we get at the end of the
production/finished products/G&S
produced.
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Microeconomics


CLASSIFICATION OF F.O.P
1. LAND – natural resources/gift of nature; land
surface, air, lakes, water, minerals, forests etc.
2. LABOUR – physical/mental activities undertaken by
man in exchange for $ reward; lawyer, farmer, PM.
3. CAPITAL – That part of man-made wealth which is
used to further produce wealth; machine, building;
not all $ is capital- sewing machine & shirt
4. ENTERPRENEUR – a person who combines the 3
above, initiates the process of prod & bear the risk.
human ability & talent.
5. TECHNOLOGY – advancements in IT
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Microeconomics


THE PRODUCTION FUNCTION
“specifies the maximum output that can be produced
from any given amount of inputs”

The prod function shows the technically efficient
ways of combining inputs to produce output.
Relationship between inputs(F.O.P) & outputs (G&S)
In math equation;
Q = f(K,L,M, etc)
Qty of output = f(capital, labour, raw material)
•
•

Means Q depends on f.o.p. f.o.p , Q
Inputs is homogeneous – only qty differ not
quality
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1201/ BBI 1113/ BBI 1114
Microeconomics


Total Revenue, Total Cost, and
Profit
• Total Revenue
– The amount a firm receives for the sale
of its output.

• Total Cost
– The market value of the inputs a firm
uses in production.

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Microeconomics

Total Revenue, Total Cost, and
Profit
• Profit is the firm’s total revenue minus its total
cost.
Profit = Total revenue - Total cost
Improving Inventory Control at
Wal-Mart
Better inventory controls have
helped reduce firms’ costs.

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Microeconomics


Costs as Opportunity Costs
• A firm’s cost of production includes all
the opportunity costs of making its
output of goods and services.
• Explicit and Implicit Costs
– A firm’s cost of production include
explicit costs and implicit costs.
• Explicit costs are input costs that require a
direct outlay of money by the firm.
• Implicit costs are input costs that do not
require an outlay of money by the firm.
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Microeconomics


Economic Profit vs Accounting
Profit
Economists measure a firm’s economic profit as total
revenue minus total cost (TR – TC), including both
explicit and implicit costs.
Accountants measure the accounting profit as the
firm’s total revenue minus only the firm’s explicit
costs.
•
When total revenue exceeds both explicit and
implicit costs, the firm earns economic profit.
Economic profit is smaller than accounting profit.
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Microeconomics


Figure 1 Economic versus Accountants
How an Economist
Views a Firm

How an Accountant
Views a Firm

Economic
profit
Accounting

profit
Revenue

Implicit
costs

Explicit
costs

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Revenue
Total
opportunity
costs

Microeconomics

Explicit
costs


Table 1 A Production Function and Total Cost:
Hungry Helen’s Cookie Factory

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Microeconomics

PRODUCTION AND COSTS
• The Production Function
– The production function shows the
relationship between quantity of inputs
used to make a good and the quantity of
output of that good.
• Marginal Product
– The marginal product of any input in the
production process is the increase in output
that arises from an additional unit of that
input.
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Microeconomics


Figure 2 Hungry Helen’s Production Function
Quantity of
Output
per hour)
Production function

150
140
130
120
110
100
90
80

70
60
50
40
30
20
10
0
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1

2

3

4

Microeconomics

Number of Workers Hired


Diminishing Marginal Product
– Diminishing marginal product is the
property whereby the marginal product of
an input declines as the quantity of the
input increases.
–
• Example: As more and more workers are hired

at a firm, each additional worker contributes
less and less to production because the firm
has a limited amount of equipment.
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Microeconomics


The Marginal Product of Labor and the
Average Product of Labor

The Law of Diminishing Returns
Marginal and Average Product of Labor at Jill Johnson’s Copy Store

QUANTITY OF
WORKERS

QUANTITY OF
COPY
MACHINES

QUANTITY OF
COPIES

MARGINAL
PRODUCT OF
LABOR

0
1

2
3
4
5
6

2
2
2
2
2
2
2

0
625
1,325
2,200
2,600
2,900
3,100

625
700
875
400
300
200

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Microeconomics


The Marginal Product of Labor and the
Average Product of Labor

Total Output and the
Marginal Product of Labor

Graphing Production

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Microeconomics


From the Production Function
to the Total-Cost Curve
• The relationship between the quantity
a firm can produce and its costs
determines pricing decisions.
• The total-cost curve shows this
relationship graphically.

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Microeconomics

Table 1 A Production Function and Total
Cost: Hungry Helen’s Cookie Factory

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Microeconomics


Figure 3 Hungry Helen’s Total-Cost Curve
Total

Total-cost
curve

$80
70
60
50
40
30
20
10

0

10 20 30 40 50 60 70

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80 90 100 110 120 130 140 150

Microeconomics

of Output
(cookies per hour)


THE VARIOUS MEASURES OF COST
Costs of production may be divided into
fixed costs and variable costs.
Fixed and Variable Costs
 Fixed costs are those costs that do not
vary with the quantity of output produced.
(rent)
 Variable costs are those costs that do
vary with the quantity of output produced.
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Microeconomics


Fixed and Variable Costs
• Total Costs
– Total Fixed Costs
(TFC)
– Total Variable Costs (TVC)
– Total Costs
(TC)

TC = TFC + TVC
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Microeconomics

The salaries of editors
are considered a fixed
cost by publishers.


Table 2 The Various Measures of Cost: Thirsty
Thelma’s Lemonade Stand

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Microeconomics


• Average Costs
– Average costs can be determined by dividing
the firm’s costs by the quantity of output it
produces. (TC/Qty)
– The average cost is the cost of each typical unit
of product.
Average Costs
Average Fixed Costs
(AFC)
Average Variable Costs (AVC)
Average Total Costs
(ATC)
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ATC = AFC
+ AVC
Microeconomics


Average Costs
F ix e d c o s t
F C
A F C 

Q u a n tity
Q
V a ria b le c o s t
V C
A V C 

Q u a n tity
Q
T o ta l c o s t
T C
A T C 

Q u a n tity
Q
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Microeconomics