Production: It is a
process of transforming inputs to output.
Product/Output: The
numbers of goods produced. For example if 1 car is produced, it is one unit of
output, if 100 cars are produced, its 100 units of output.
Factors involved in production
The factors involved in the
production can classified as fixed factors and variable factors.
- Fixed Factors: The factors whose supply cannot be quickly or easily changed over a short period. It can only be changed over the long run. Example: Factory Building, Heavy specialised machinery and Fixtures and Fitting
- Variable Factors: The factor supply can be easily changed both in short run and long run. Example: Labour, Raw materials, fuel, power and hand tools.
There are two time periods in
Economics, short run and long run.
1.
The short
run
-
Short run refers to a short period of time over which at
least one factor would be fixed.
-
If a firm wants to change its output in the short run,
they would be able to change only its variable factors to bring a change in its
output.
-
There are fixed factors in the short run.
2.
The long run
-
Long run refers to a period of time over which the firm
can change all its factors.
-
If a firm wants to change its output in the long run,
they would be able to change all its factors.
-
There are no fixed factors in the long run. In the long
run all the factors are variable.
Costs
Costs are expenses a firm has to
bear during the process of the production. There are three types of costs. They
are:
Fixed Costs: These are
the costs of fixed factors of production. The cost of production does not vary
with the change in the output. As firm increases or decreases the fixed always
remain unchanged. Fixed costs are also known as indirect or overhead
costs. Examples: Rent, insurance
premium, Managers Salary and interest payment on a loan. The diagram represents
the fixed cost schedule a firm faces:
Variable costs: Variable
costs are cost of production which varies directly with the change in output.
If more goods are produced cost of production is likely to increase. It is also
known as direct costs. Examples: raw material costs, power linked in
production, wages linked to production. The following diagram represents
variable costs.
Total Cost: Total cost of
producing a given amount of goods and services.
-
When output increases the total cost also increases and
vice-versa.
-
This is because when output increases, variable cost
increases. So this increase in VC is also shown in the total cost.
Total cost can be calculated as
follow:
Total
Cost = Fixed Cost + Variable Costs
In
a diagram it can be represented as follow:
Average Total Cost (AC/ATC)
ATC is the total cost per unit of
output produced. It can be calculated by the following formula.
Average Fixed Cost (AFC): AFC is
the fixed cost per unit of output. It can be calculated by the following
formula:
Average Variable Cost (AVC): AVC
is the average cost per unit of output. . It can be calculated by the following
formula:
Marginal Cost (MC) :
Marginal cost incurred by employing an additional unit of factor of production.
. Marginal cost measure the change in total cost for an increase in one unit of
output. The following two examples depict marginal costs of an increase in
scale of production.
MC can be calculated by the following
formula.
EXAMPLE 1:
Output
|
Total Cost
|
Marginal Cost
|
||||||||||
0
|
132
|
|
||||||||||
1
|
143
|
|||||||||||
2
|
152
|
|||||||||||
3
|
163
|
|||||||||||
4
|
177
|
|||||||||||
5
|
199
|
Always deduct the 2nd
Number from the first number (143 – 132) to get the marginal cost. Write your
answer between the two numbers.
Fr example, 143-132
1-0
= 11/1
= 11
EXAMPLE 2:
Output
|
Total Cost
|
Marginal Cost
|
||||||||||
0
|
142
|
|
||||||||||
2
|
188
|
|||||||||||
5
|
193
|
|||||||||||
7
|
223
|
|||||||||||
11
|
342
|
|||||||||||
15
|
484
|
Here MC was calculated as:
The
graph of Marginal cost can be shown as below.
There are various features of MC curve to be noted. First it
goes down till it reaches a minimum point and then keeps on increasing.
The Nature of the
Marginal Cost (MC) and Average cost (AC) Curves
-
The marginal cost and the average cost is in “U” shape.
-
Initially, as output increases, MC and AC will be
falling as cost can be shared among an increased number of outputs.
-
But if the output continues to increase after some
point, the productivity starts to decline which increases the cost as more
output is produced, hence MC and AC starts increasing.