ECO 1013: PRODUCTION & COST

DEFINITION OF PRODUCTION

-Production means the transformation of inputs into outputs

INPUT is things that a firm buy for use in production process .

Ex : land , labour, capital , entrepreneur

OUTPUT is what we get at the end of the production process

SHORT RUN & LONG RUN PRODUCTION

Short-run period

Time frame in which at least one of the inputs is fixed but the other inputs are varied . Ex : building, equipment, tools

Long-run period

Time frame in which all inputs are variable

Fixed input

An input which the quantity does not change according to output . Ex : Machinery , land , building

Variable input

An input which the quantity changes according to output . Ex : raw materials , transportation

TYPES OF PRODUCTION

a. primary production

Industries that involved in the first stage on the production process . It included the extractive industries such as coal mining , iron , agricultural , etc . These industries provide the raw material which are made into finished goods .

b. secondary production

Industries involved in manufacturing he finished goods from he raw materials . It included textile manufacturers , motorcar industries , etc

c. Tertiary production

Provide services which enable the production of goods by primary and secondary producers to take place for effective . Consists of two parts : commercial services and direct services

i. Commercial services

These include all those industries engaged in the movement of commodities so that they reach the final consumer on time , in good condition and in the correct quantity . Ex : Maybank , Tesco , Mas Cargo etc

ii. Direct services

Direct to consumer by example , Doctors and teachers . They are important to the production process because they increase efficiency . Ex : Hospitals , College , etc

LAW OF DIMINISHING MARGINAL RETURNS

The situation when producer increase , the input to output will be increase at decreasing rates .

Total product (TP) is the amount of output produced when a given amount of that input used together with fixed inputs .

Average product (AP) can be obtained by dividing the total product by the amount of that input used , In this case , labour is used .

Marginal Product (MP) is the additional to total product when one more unit of labour is employed .

If capital is used as a variable input ,

The table below shows the relationship between output and labour when the capital is fixed .

Fixed inputs Capital (K)	Variable inputs Labours (L)	Total Product (TP)	Average product (AP)	Marginal Product (MP)
1	0	0	0	0
1	1	5	5	5
1	2	12	6	7
1	3	35	11.7	23
1	4	53	13.3	18
1	5	65	13	12
1	6	72	12	7
1	7	72	10.3	0
1	8	70	8.8	-2

The diagram above show the relationship between AP, MP, and TP

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 its 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 is below AP , AP is decreasing
· When MP is equals to AP , AP is at maximum

COST OF PRODUCTION

Ø Cost of production refers to the expenses incurred by the producer in producing a particular quantity of output.

There are 7 types of short-run costs :

i. Total fixed cost

ii. Total variable cost

iii. Total cost

iv. Average fixed cost

v. Average variable cost

vi. Average cost

vii. Marginal cost

Total fixed cost (TFC) , Total variable cost (TVC) , Total cost (TC)

Consider the following hypothetical example of a boat building firm. The total fixed costs, TFC, include premises, machinery and equipment needed to construct boats, and are £100,000, irrespective of how many boats are produced. Total variable costs (TVC) will increase as output increases.

Plotting this gives us Total Cost, Total Variable Cost, and Total Fixed Cost.

Total fixed costs

Given that total fixed costs (TFC) are constant as output increases, the curve is a horizontal line on the cost graph.

Total variable costs

The total variable cost (TVC) curve slopes up at an accelerating rate, reflecting the law of diminishing marginal returns

Total costs

The total cost (TC) curve is found by adding total fixed and total variable costs. Its position reflects the amount of fixed costs, and its gradient reflects variable costs.

Average total cost (ATC) can be found by adding average fixed costs (AFC) and average variable costs (AVC). The ATC curve is also ‘U’ shaped because it takes its shape from the AVC curve, with the upturn reflecting the onset of diminishing returns to the variable factor.

Average fixed costs ( AFC )

Average fixed costs are found by dividing total fixed costs by output. As fixed cost is divided by an increasing output, average fixed costs will continue to fall.

Average variable costs ( AVC )

Average variable costs are found by dividing total fixed variable costs by output.

Average cost ( AC )

Average costs are a key cost in the theory of the firm because they indicate how efficiently scarce resources are being used. Average variable costs are found by dividing total fixed variable costs by output. Total Fixed costs and Total Variable costs are the respective areas under the Average Fixed and Average Variable cost curves

Marginal cost (MC)

Refers to the change in the total cost (or TVC ) those results from producing another unit of output. MC is the change in TC or TVC divided by the change in output.