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Production Cost
are those which must be received by resource owners in order to
assume that they will continue to supply them in a particular time of
production.
Cost of Production
is meant the total sum of money required for the production of a
specific quantity of output.
Types/Classifications of Cost of Production:
According to Prof, Mead in his book, "Economic Analysis and Policy" has
classified these costs into three main sections:
(1) Production Costs:
It includes material costs, rent cost, wage cost, interest cost and normal
profit of the entrepreneur.
(2) Selling Costs:
It includes transportation, marketing and selling costs.
(3) Sundry Costs:
It includes other costs such as insurance charges, payment of taxes and rate,
etc.
Measuring Cost: Which Costs Matter?
1. For a firm to minimize costs, we must clarify what is meant by costs and how
to measure them
1.1. It is clear that if a firm has to rent equipment or buildings, the rent they
pay is a cost
1.2. What if a firm owns its own equipment or building?
1.1.1. How are costs calculated here?
2. Accountants tend to take a retrospective view of firms’ costs, whereas
economists tend to take a forward-looking view
3. Accounting Cost
Actual expenses plus depreciation charges for capital equipment
Measuring Cost: Which Costs Matter?
4. Economic Cost
Cost to a firm of utilizing economic resources in production, including
opportunity cost
5 . Economic costs distinguish between costs the firm can control and
those it cannot
Concept of opportunity cost plays an important role
6. Opportunity cost
Cost associated with opportunities that are foregone when a firm’s
resources are not put to their highest-value
Total cost can be divided into:
1. Fixed Cost (FC)
Does not vary with the level of output
2. Variable Cost (VC)
Cost that varies as output varies
TC-FC+VC
Which costs are variable and which are fixed depends on the time
horizon?
• Short time horizon – most costs are fixed
• Long time horizon – many costs become variable
• In determining how changes in production will affect costs, must consider if
fixed or variable costs are affected.
Marginal and Average Cost
Measuring Costs
The marginal revenue is the change in total revenue attributable to the last unit of
output; geometrically, it is the slope of the total revenue curve.
Figure (a) (graph above) – shows the marginal revenue schedule for a monopolist
lies below the demand curve; in fact, for a linear demand curve, the marginal revenue
schedule lies exactly halfway between the demand curve and the vertical axis.
A monopolist, marginal revenue is less than the price charged for good. There are two
ways to understand why the marginal revenue schedule lies below the monopolist’s demand
curve. Consider first a geometric explanation marginal revenue is the slope of the total revenue
curve [R(Q)] figure (b). Over this range marginal revenue decreases until it reaches zero when
output is Q0. As output expands beyond Q0, the slope of the total revenue curve becomes
negative and gets increasingly negative as output continues to expand.
Monopolistic Competition – is a market structure that lies between the
extremes of monopoly and perfect competition. This market structure
exhibits some characteristics present in both perfect competition and
monopoly.
❑Productivity measurement
A nation or an industry advances by using less to make more. Labour productivity is
an especially sensitive indicator of this economizing process and is one of the major
measures used to chart a nation’s or an industry’s economic advance.
Productivity is valuable also as an indicator of comparative rates of change among
industries and products. Growth in general can be better understood if the relative
contributions of individual industries and the circumstances underlying productivity changes
in each of these industries are understood.
THE MAJOR PROBLEM INCLUDES:
❑Measure of efficiency
Productivity is also used to measure efficiency, as an aid in economic planning
and forecasting, and as a means of assessing the uses to which resources are being put.
As to the first of these, the efficiency of industrial operations, for instance, may be
evaluated by the yardstick of output per worker or machine, and such a yardstick may
also provide the basis for supplemental or premium payments for workers.
THE MAJOR PROBLEM INCLUDES:
❑Measurement of productivity
As a prelude to an examination of productivity trends over time,
this section considers various methods of measuring the output and input
components of productivity ratios and some of the difficulties and
limitations of the resulting estimates.
THE MAJOR PROBLEM INCLUDES:
❑Output
With respect to output, ideally the numbers of units of each category of tangible commodity or
service should be counted in successive time periods and aggregated for the firm, industry, or total
economy in terms of some indicator of relative importance, usually price or cost per unit as of a
particular period.
The unit value “weights”—price, cost, or other—must be held constant for two or more periods
being compared so that changes in aggregate output reflect changes in physical volumes rather than in
prices. An alternative procedure that produces the same results with ideal data is to “deflate” current
values of the various items produced by index numbers that reflect relative price changes in order to
eliminate the effects of price changes.
Price deflation is usually employed to obtain estimates of real gross product by sector and
industry to be used as numerators of productivity ratios. For tangible industrial production measures,
quantities of the various commodities are generally weighted together by constant unit values.
THE MAJOR PROBLEM INCLUDES:
❑Inputs
Labour input is relatively easy to measure if one is content to count heads of persons
engaged in production or, preferably, hours worked.
Capital input is usually assumed to change in the same direction as and proportionally
to changes in the real stocks of structures, equipment, inventories, and natural resources. The
rates of return on those capital goods in some base period are taken to be indicative of their
productivity for the purpose of weighting them together with other factor inputs. Some analysts
adjust the capital estimates to take into account changing rates of utilization of capacity;
otherwise, changes in utilization rates are reflected in the productivity estimates.
THE MAJOR PROBLEM INCLUDES:
❑Inputs
Interindustry purchases and sales of intermediate products—those materials, energy,
and other services that are consumed in the production process—are accounted for on a value-
added basis and cancel out in the national income and product estimates by industry (one
industry’s output being the next one’s input).