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# Product And Cost

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### Product And Cost

1. 1. Production <ul><li>Production </li></ul><ul><li>Is an organized activities of converting inputs into output or creation of value and utility </li></ul><ul><li>Factors of production – Rewards </li></ul><ul><li>Land - rent </li></ul><ul><li>Labor - wages </li></ul><ul><li>Capital - interest </li></ul><ul><li>Organization - profit </li></ul>
2. 2. Production function <ul><li>Production function – </li></ul><ul><li>The functional relationship between physical inputs and physical output </li></ul>
3. 3. Production Function With One Variable Input Total Product Marginal Product Average Product Production or Output Elasticity TP = Q = f(L) MP L =  TP  L AP L = TP L E L = MP L AP L
4. 4. Production Function With One Variable Input Total, Marginal, and Average Product of Labor, and Output Elasticity
5. 5. Production Function With One Variable Input
6. 6. Production Function With One Variable Input
7. 7. Production function <ul><li>1. Production function for a firm is Q = 100L – 0.02L 2 . If 10 units of labor are used, What is the maximum average productivity of labor? </li></ul><ul><li>2. If the average product of labor (AP L ) is 30L – L 2 , What is the maximum possible total product (TP L ) ? </li></ul><ul><li>3. The Production function of a manufacturing unit, using only labor (L) as inputs in the production process, is estimated to be Q = 100 L 2 – L 3 . What is the number of labor input at which the firm can maximize average productivity ? and What is the maximum average productivity at that input level? </li></ul>
8. 8. Optimal Use of the Variable Input Marginal Revenue Product of Labor MRP L = (MP L )(MR) Marginal Resource Cost of Labor MRC L = Optimal Use of Labor MRP L = MRC L  TC  L
9. 9. Optimal Use of the Variable Input Use of Labor is Optimal When L = 3.50
10. 10. Optimal Use of the Variable Input
11. 11. Production With Two Variable Inputs Isoquants show combinations of two inputs that can produce the same level of output. Firms will only use combinations of two inputs that are in the economic region of production , which is defined by the portion of each isoquant that is negatively sloped.
12. 12. Production With Two Variable Inputs Isoquants
13. 13. Production With Two Variable Inputs Economic Region of Production
14. 14. Production With Two Variable Inputs Marginal Rate of Technical Substitution MRTS = -  K/  L = MP L /MP K
15. 15. Production With Two Variable Inputs MRTS = -(-2.5/1) = 2.5
16. 16. Production With Two Variable Inputs Perfect Substitutes Perfect Complements
17. 17. Optimal Combination of Inputs Isocost lines represent all combinations of two inputs that a firm can purchase with the same total cost.
18. 18. Optimal Combination of Inputs Isocost Lines AB C = \$100, w = r = \$10 A’B’ C = \$140, w = r = \$10 A’’B’’ C = \$80, w = r = \$10 AB* C = \$100, w = \$5, r = \$10
19. 19. Optimal Combination of Inputs MRTS = w/r
20. 20. Production function <ul><li>1. Production function of a firm is </li></ul><ul><li>Q = 4L 2 + 6K 2 – 2LK </li></ul><ul><li>Budget constraint of the firm is Rs.720. The market going wage rate w = Rs.10 and cost of capital r = Rs.10 </li></ul><ul><li>a.The optimum input quantities of Labour and Capital and the output at that input  quantities </li></ul><ul><li>b.The optimum output if both the wage rate and cost of capital increase to Rs. 15. </li></ul><ul><li>2.Suppose the price of labour is Rs.10 and the price of capital is Rs.2.5 </li></ul><ul><li>Use this information to determine the isocost equations corresponding to a total cost of Rs.200 and Rs.500 </li></ul><ul><li>Plot these two iso-cost lines on a graph </li></ul><ul><li>If the price of labour falls from Rs.10 per unit to Rs. 8 per unit, determine the new Rs.500 iso-cost line and plot it on the same diagram used in part (b) </li></ul>
21. 21. Optimal Combination of Inputs <ul><li>Effect of a Change in Input Prices </li></ul>
22. 22. Returns to Scale Production Function Q = f(L, K)  Q = f(hL, hK) If  = h, then f has constant returns to scale. If  > h, then f has increasing returns to scale. If  < h, the f has decreasing returns to scale.
23. 23. Returns to Scale Constant Returns to Scale Increasing Returns to Scale Decreasing Returns to Scale
24. 24. Returns to Scale Returns to Scale Constant Returns to Scale Increasing Returns to Scale Decreasing Returns to Scale
25. 25. Innovations and Global Competitiveness <ul><li>Product Innovation </li></ul><ul><li>Process Innovation </li></ul><ul><li>Product Cycle Model </li></ul><ul><li>Just-In-Time Production System </li></ul><ul><li>Competitive Benchmarking </li></ul><ul><li>Computer-Aided Design (CAD) </li></ul><ul><li>Computer-Aided Manufacturing (CAM) </li></ul>
26. 26. Economies of scale and scope <ul><li>Internal economies </li></ul><ul><li>External economies </li></ul>
27. 27. Internal economies <ul><li>Labor economies </li></ul><ul><li>Managerial economies </li></ul><ul><li>Financial economies </li></ul><ul><li>Marketing economies </li></ul><ul><li>Technical economies </li></ul>
28. 28. External economies <ul><li>Economies of localization </li></ul><ul><li>Economies of marketing intelligence and information </li></ul><ul><li>Economies of vertical disintegration </li></ul><ul><li>Economies of byproducts </li></ul>
29. 29. Basic cost concepts <ul><li>Explicit cost and Implicit cost </li></ul><ul><li>Opportunity cost </li></ul><ul><li>Marginal cost and incremental cost </li></ul><ul><li>Real cost </li></ul><ul><li>Controllable cost </li></ul><ul><li>Traceable cost and common costs </li></ul><ul><li>Fixed cost and variable cost </li></ul>
30. 30. Short-Run Cost Functions <ul><li>Total Cost = TC = f(Q) </li></ul><ul><li>Total Fixed Cost = TFC </li></ul><ul><li>Total Variable Cost = TVC </li></ul><ul><li>TC = TFC + TVC </li></ul>
31. 31. Short-Run Cost Functions <ul><li>Average Total Cost = ATC = TC/Q </li></ul><ul><li>Average Fixed Cost = AFC = TFC/Q </li></ul><ul><li>Average Variable Cost = AVC = TVC/Q </li></ul><ul><li>ATC = AFC + AVC </li></ul><ul><li>Marginal Cost =  TC/  Q =  TVC/  Q </li></ul>
32. 32. Short-Run Cost Functions
33. 34. Long-Run Cost Curves <ul><li>Long-Run Total Cost = LTC = f(Q) </li></ul><ul><li>Long-Run Average Cost = LAC = LTC/Q </li></ul><ul><li>Long-Run Marginal Cost = LMC =  LTC/  Q </li></ul>
34. 35. Long-run average cost curve
35. 36. Learning and costs <ul><li>Job familiarization and less time to instruct workers </li></ul><ul><li>More skillful movements of workers </li></ul><ul><li>Better operation sequences, machine-feeds and speeds </li></ul><ul><li>Less rejection and rework </li></ul><ul><li>Manufacturing lots are larger, cutting down the set-up time proportion </li></ul><ul><li>Improved coordination and management controls </li></ul>
36. 37. Learning Curves
37. 38. Minimizing Costs Internationally <ul><li>Foreign Sourcing of Inputs </li></ul><ul><li>New International Economies of Scale </li></ul><ul><li>Immigration of Skilled Labor </li></ul>
38. 39. Logistics or Supply Chain Management <ul><li>Merges and integrates functions </li></ul><ul><ul><li>Purchasing </li></ul></ul><ul><ul><li>Transportation </li></ul></ul><ul><ul><li>Warehousing </li></ul></ul><ul><ul><li>Distribution </li></ul></ul><ul><ul><li>Customer Services </li></ul></ul><ul><li>Source of competitive advantage </li></ul>
39. 40. Logistics or Supply Chain Management <ul><li>Reasons for the growth of logistics </li></ul><ul><ul><li>Advances in computer technology </li></ul></ul><ul><ul><ul><li>Decreased cost of logistical problem solving </li></ul></ul></ul><ul><ul><li>Growth of just-in-time inventory management </li></ul></ul><ul><ul><ul><li>Increased need to monitor and manage input and output flows </li></ul></ul></ul><ul><ul><li>Globalization of production and distribution </li></ul></ul><ul><ul><ul><li>Increased complexity of input and output flows </li></ul></ul></ul>
40. 41. Tools of cost control <ul><li>Budgetary control </li></ul><ul><li>Standard Costing </li></ul><ul><li>Ratio analysis </li></ul><ul><li>Value analysis </li></ul>
41. 42. Areas of cost control <ul><li>Material cost </li></ul><ul><li>Labour cost </li></ul><ul><li>Overhead cost </li></ul><ul><li>Selling cost </li></ul>
42. 43. Approaches to cost reduction <ul><li>Budgetary </li></ul><ul><li>Input reduction </li></ul><ul><li>Input cost </li></ul><ul><li>Input substitution </li></ul><ul><li>“ Not made here” </li></ul><ul><li>Suggestions box </li></ul>
43. 44. George Stigler’s Survivorship Technique <ul><li>Classify various firms in an industry under study by size groups or classes </li></ul><ul><li>Determine which size groups or classes are increasing or decreasing their share of the total output </li></ul><ul><li>If the share of a given size-class falls, that size class is relatively inefficient and in general, more inefficient the size group, more rapidly the share falls. Likewise, the size-class whose share in industry grows the most, is regarded as most efficient size- class or group </li></ul><ul><li>The technique gives the optimum size of a firm only and that too in terms of output range or the size group. Butit does not yield the cost function </li></ul>
44. 45. Cost-Volume-Profit Analysis <ul><li>Total Cost-Volume-Profit Analysis Revenue = TR = (P)(Q) </li></ul><ul><li>Breakeven Volume TR = TC </li></ul><ul><li>(P)(Q) = TFC + (AVC)(Q) </li></ul><ul><li>QBE = TFC/(P - AVC) </li></ul>
45. 46. Cost-Volume-Profit Analysis
46. 47. Operating Leverage
47. 48. Break Even Analysis <ul><li>TR = TC </li></ul><ul><li>In units - </li></ul><ul><li>BEP = TFC/CM </li></ul><ul><li>In value - </li></ul><ul><li>BEP = TFC/ P.V.Ratio </li></ul>
48. 49. Managerial Applications of BEP <ul><li>Price and Cost decision </li></ul><ul><li>Target Profit </li></ul><ul><li>Margin of safety </li></ul><ul><li>Product mix decision </li></ul><ul><li>Selection of technology </li></ul><ul><li>Decision on promotional expenditure </li></ul><ul><li>Make or buy decisions </li></ul>