Your SlideShare is downloading. ×
Cost of production
Upcoming SlideShare
Loading in...5
×

Thanks for flagging this SlideShare!

Oops! An error has occurred.

×

Introducing the official SlideShare app

Stunning, full-screen experience for iPhone and Android

Text the download link to your phone

Standard text messaging rates apply

Cost of production

1,756
views

Published on

Micro-economics, Cost of production explained

Micro-economics, Cost of production explained

Published in: Education

0 Comments
1 Like
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total Views
1,756
On Slideshare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
105
Comments
0
Likes
1
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
No notes for slide

Transcript

  • 1. COST OFPRODUCTIONMICROECONOMICSSUBMITTED TO: Miss FOUZIA AWANSUBMITTED BY:BILAL AHMAD 12002001006,SAJID NADEEM 12002001004,MEHMAN ALI 12002001005BS.AM 1/14/2013
  • 2. COST OF PRODUCTION 2013Table of ContentsCost of Production ........................................................................................................................................ 2 Total Cost .................................................................................................................................................. 2 Total Revenue ........................................................................................................................................... 2 Profit ......................................................................................................................................................... 2 Opportunity Cost ....................................................................................................................................... 2Explicit Costs ................................................................................................................................................ 3Implicit Costs ................................................................................................................................................ 3Economic Profit vs. Accounting Profit ......................................................................................................... 4Economic Profit ............................................................................................................................................ 5The Production Function............................................................................................................................... 5Law of Diminishing marginal product .......................................................................................................... 6Comparison of Total Cost Curve and Production Function .......................................................................... 7Various Measures of Cost ............................................................................................................................. 7 Fixed Cost ................................................................................................................................................. 8 Variable Cost ............................................................................................................................................ 8 Total Cost .................................................................................................................................................. 8 Average Total Cost ................................................................................................................................... 8 Average Fixed Cost................................................................................................................................... 8 Average Variable Cost .............................................................................................................................. 8 Marginal Cost............................................................................................................................................ 8Shapes of Cost Curves .................................................................................................................................. 9Relationship between ATC and MC ........................................................................................................... 10Relationship between ATC, AFC, and AVC. ............................................................................................. 10 1|Page
  • 3. COST OF PRODUCTION 2013Cost of ProductionIn economics, the cost-of-production is the price of a good which is determined by the sum of thecost of the resources that went into making it. The cost can compose any of the factors ofproduction (including labor, entrepreneur, capital, or land) and taxation.Total CostCost is the market value of inputs that a company uses in production of certain good.Total RevenueThe amount a firm receives for the sale of its output.ProfitTotal revenue – Total costOpportunity CostThe value of most appealing alternative that is not chosen is called opportunity cost. It is the costof something is what you give up to get it i.e. the cost of an item refers to all those things thatmust be forgone to acquire that item.ExampleOpportunity cost is the value of something you give up to obtain another thing. It can also bethought of as "the next best thing". Opportunity cost is not monetary but can be applied whenmoney is involved. An example of opportunity cost would be if you have two choices: to workall day and make some money or to take the day off and go to a movie that you have beenwaiting to see for a long time. If you choose the movie, the opportunity cost is the money thatyou couldve made working all day. If you choose the work, the opportunity cost is the joy youwould receive from seeing the movie.i 2|Page
  • 4. COST OF PRODUCTION 2013Opportunity cost = Explicit cost + Implicit costThe opportunity cost of a decision is based on what must be given up (the next best alternative)as a result of the decision. What must be given up can be either explicit cost or implicit cost. It isii this combination of implicit and explicit costs that when combined; make up the totalopportunity cost.iiiExplicit CostsInput cost that requires an outlay of money by the firm is called explicit cost. Explicit costs arepayments to non-owners of a firm for their resources. Explicit costs represent obvious cashoutflows from businesses that reduce its bottom-line profitability. Some of the resources the firmneeds must be purchased or hired from outside the firm and thus must be obtained on payment.Such resources include electricity, fuel, raw materials, labor, insurance, etc.; these are items forwhich payments are made.Real Life Explicit Cost ExampleSuppose you and five friends - six entrepreneurs - get together and open up a computer softwarefirm that produces specialized computer software. Some of the payments that must be made forthe production of the software are termed explicit costs. For example, these explicit costs mightinclude computer hardware, utilities, supplies, property and other taxes, maintenance costs,payments to wholesalers for the materials needed to produce the software, and the salaries ofoffice support staff.Implicit CostsAn implicit cost is a cost that is represented by lost opportunity in the use of a companys ownresources, excluding cash. Since these resources are not obtained by direct monetary payments(as were the resources for which explicit costs were paid), these costs are termed implicit costs.For example, the time and effort that an owner puts into the maintenance of the company ratherthan working on expansion is an implicit cost.Real Life Implicit Cost ExampleIn the example above, if the entrepreneurs that started the computer software firm own the smallbuilding outright within which they operate, use their own funds (in equal amounts =$50,000each) to finance the startup of the computer firm, and each put in 60 hours a week into thesoftware business, then the implicit cost of such resources would include the lease payment orrent they would otherwise receive for the use of the building, the interest or dividends their 3|Page
  • 5. COST OF PRODUCTION 2013money could earn if invested elsewhere, and the salaries they could earn if they were employedin another business.Economic Profit vs. Accounting ProfitUnderstanding Accounting ProfitAn accounting profit is the excess of business income over the business expenses. The businessearns money after selling their goods or services. If the money they earn is more than the moneythey spend for making/providing the goods/services, it is said that the business has made anaccounting profit. So once all these costs are reduced from the total income earned by a businessenterprise, if the remaining amount is positive, it is an accounting profit. If the remaining amountis negative, it is known as an accounting loss, which means that the business has spent beyond itsearning capacity in the accounting period. Thus we can say that an accounting profit is the excessof accounting income over accounting expenses.Accounting Profit = Total Income - Total Expensesiv 4|Page
  • 6. COST OF PRODUCTION 2013Economic ProfitTotal revenue minus total cost including implicit and explicit costs is called economic profit. It isthe difference between the revenue received from the sale of an output and the opportunity costof the inputs used.Economic Profit = Total Income - Total Expenses - Opportunity Lost CostEconomic profit is always less than the accounting profit.The Production FunctionIt is the relationship between quantity of input used to make good and the quantity of output. Theproduction function describes the maximum output that can be produced from any combinationof inputs available in a given time period.Table shows an example of the quantity of cookies Helen’s factory produces per hour dependson the number of workers.No. of Output Marginal Fixed cost/ Variable cost/ Total cost ofworkers/ quantity of product cost of factory cost of inputs=quantity cookies workers F.C+V.C produced/hour0 0 $30 $0 $30 $501 50 30 10 40 402 90 30 20 50 303 120 30 30 60 204 140 30 40 70 105 150 30 50 80 56 155 30 60 90 5|Page
  • 7. COST OF PRODUCTION 2013Production function and T.C curve is shown in graphs.Law of Diminishing marginal productThe property where the marginal product of an input declines as the quantity of the inputincreases is called law of diminishing marginal product.The law of diminishing returns states that as one type of production input is added, with all othertypes of input remaining the same, at some point production will increase at a diminishing rate.There may be levels of input where increasing inputs causes production to go up at an increasingrate. However, according to the law of diminishing returns, at some point production will go upat a decreasing rate. 6|Page
  • 8. COST OF PRODUCTION 2013Comparison of Total Cost Curve and Production FunctionThe total cost curve gets steeper as the amount produces rises, whereas the production functiongets flatter as the production increases. This is due to the law of diminishing marginal product asthe production increases the production area become more crowded due to increase in workers.Thus each additional worker adds less to the production. Therefore production function isrelatively flat.When the production area is crowded then producing an additional unit requires a lot ofadditional workers and thus very costly. Therefore when the quantity produce is large, the totalcost curve is relatively steep.Various Measures of CostThere are various types of costs which is described below with the help of table. Marginal cost Average Average Average Fixed Variable Total Change inQuantity fixed variable total cost= cost cost cost=F.C+V.C total cost=FC/Q cost=VC/Q AFC+AVC cost/change in quantity0 $3 $0.0 $3 --- --- --- $0.31 3 0.3 3.3 $3.0 $0.30 $3.3 0.52 3 0.8 3.8 1.5 0.40 1.9 0.73 3 1.5 4.5 1.0 0.50 1.5 0.94 3 2.4 5.4 0.75 0.6 1.35 1.15 3 3.5 6.5 0.6 0.7 1.30 1.36 3 4.8 7.8 0.5 0.8 1.30 1.57 3 6.3 9.3 0.43 0.9 1.33 1.78 3 8.0 11.0 0.38 1.0 1.38 1.99 3 9.9 12.9 0.33 1.10 1.43 2.110 3 12 15.0 0.30 1.20 1.50 7|Page
  • 9. COST OF PRODUCTION 2013Fixed CostCosts that do not vary with the quantity of output produced.In economics, fixed costs arebusiness expenses that are not dependent on the level of goods or services produced by thebusiness. They tend to be time-related, such as salaries or rents being paid per month.vVariable CostCosts that do vary with the quantity of output produced.Variable costs are expenses that changein proportion to the activity of a business. Variable cost is the sum of marginal costs over allunits produced. It can also be considered normal costs.For example, a firm pays for raw materials. When activity is decreased, less raw material is used,and so the spending for raw materials falls. When activity is increased, more raw materials isused and spending therefore rises. Note that the changes in expenses happen with little or noneed for managerial intervention. These costs are variable costs.viTotal CostF.C+V.CAverage Total CostTotal cost divided by the quantity of output.In economics, average cost or unit cost is equal tototal cost divided by the number of goods produced (the output quantity, Q). It is also equal tothe sum of average variable costs (total variable costs divided by Q) plus average fixed costs(total fixed costs divided by Q).viiAverage Fixed CostFixed cost divided by the quantity of output.Average Variable CostVariable cost divided by the quantity of output.Marginal CostThe increase in total cost that arises from an extra unit of production.The increase or decrease inthe total cost of a production run for making one additional unit of an item. It is computed insituations where the breakeven point has been reached: the fixed costs have already beenabsorbed by the already produced items and only the direct (variable) costs have to be accountedfor.Marginal costs are variable costs consisting of labor and material costs, plus an estimated portionof fixed costs (such as administration overheads and selling expenses). In companies whereaverage costs are fairly constant, marginal cost is usually equal to average cost. However, inindustries that require heavy capital investment (automobile plants, airlines, mines) and havehigh average costs, it is comparatively very low. The concept of marginal cost is criticallyimportant in resource allocation because, for optimum results, management must concentrate itsresources where the excess of marginal revenue over the marginal cost is maximum. Also calledchoice cost, differential cost, or incremental cost.viii 8|Page
  • 10. COST OF PRODUCTION 2013Shapes of Cost CurvesCost CurvesThe short-run marginal cost (MC) curve will at first decline and then will go up at some point,and will intersect the average total cost and average variable cost curves at their minimum points.The average variable cost (AVC)The average variable cost (AVC) curve will go down (but will not be as steep as the marginalcost), and then go up. This will not go up as fast as the marginal cost curve.The average fixed cost (AFC)The average fixed cost (AFC) curve will decline as additional units are produced, and continue todecline.The average total cost (ATC)The average total cost (ATC) curve initially will decline as fixed costs are spread over a largernumber of units, but will go up as marginal costs increase due to the law of diminishing returns.The graph below illustrates the shapes of these curves.ix 9|Page
  • 11. COST OF PRODUCTION 2013Relationship between ATC and MCWhen MC is below ATC, ATC must be declining. When MC is above ATC, ATC must berising. Therefore, MC crosses ATC at the minimum of ATC.Relationship between ATC, AFC, and AVC.AFC plus AVC equals ATC.i http://apecon3.wikispaces.com/Opportunity+Costii http://www.buzzle.com/articles/economic-profit-vs-accounting-profit.htmiii http://econ651spring2008.wikispaces.com/Opportunity+costs+including+implicit+costs+and+explicit+costsiv http://www.buzzle.com/articles/economic-profit-vs-accounting-profit.htmlv http://en.wikipedia.org/wiki/Fixed_costvi http://en.wikipedia.org/wiki/Variable_costvii http://en.wikipedia.org/wiki/Average_total_costviii http://www.businessdictionary.com/definition/marginal-cost.htmlix http://www.investopedia.com/exam-guide/cfa-level-1/microeconomics/marginal-average-total-cost-curve.asp#axzz2HwxMSh8p 10 | P a g e