Economics Year 10

Chapter 12 Organizing Production

Three factors of production

To produce goods and services, resources must be used. These resources are the "factors of production". These resources are Land, Labor, and Capital.

Land: The natural resources that people use: Forests, pasture land, minerals, water, etc.

Labor: The human ability to produce a good or service: Talents, skills, physical labor, etc.

Capital: Goods made by people to be used specifically to produce goods and services: Tools, office equipment, roads, factories, etc.

Another factor of production is Entrepreneurship. An entrepreneur is someone who puts all the factors of production together to make a good or service. Without any entrepreneurship, no good or service would be produced.

In a market economy, there are two markets: The "factor market", The "product market".

In the factor market

the people, who own the factors of production, sell their services to the companies that produce products. In exchange, the companies give the workers wages and , rent, and interest. In the factor market, the people are the sellers, and the companies are the buyers. The people are selling their services to the production firms.

In the product market,

companies sell the products they have produced to the people who pay money to the companies for them. The money is flowing in the opposite direction this time; people are buying products from the producing firms.

In this way, money flows through the economy in a circle.

The money goes from the producers to the workers in the form of wages, and the money then flows back to the producers in the form of payment for products.

An in consumer demand for goods & services = the demand for labour and capital by firms An in the productivity of labour = demand for factors of production. productivity means more output can be produced from same input of labour and capital. firm can reduce production cost (efficiency) and profit. Thus: productivity of its resources = efficiency Example: Technological advance = productivity, lower cost, efficiency Firms substitute labour with automated production.

TR TC ( Variable cost + Fixed Cost) = Profit Variable cost = wages and materials Fixed Cost = HP, Loans and rents scale of production big firm cost advantage as Economies of scale If too big, diseconomies of scale Rising cost , mismanagement and coordination problems Firms can increase scale of output merging/ JV with other firms Example: Chevrolet and HICOM/ Mitsubishi and Proton, KIA and NAZA/ Perodua and Daihatsu

What is Production?

Goods & Services are produced - to satisfy wants Production Making the goods and the production of services to satisfy peoples needs Converting raw materials to finished products IN ECONOMIC TERMS the process of which inputs are combined, transformed, and turned into outputs for the satisfaction of consumers

ENTREPRENEURS DECIDE What to produce How to produce By combining resources to produce output, people are willing and able to buy, productive activity adds value to resources 1 million chocolates bars sold for $1 each but cost only $600000 to produce. Firm added $400K to the value of resources used in production

Difference between Production and Productivity

Suppose 2 firms making same shoes and have the following weekly output Firm A 10000 pairs Firm B 5000 Firm A production is twice as great as of Firm B But if Firm A is using more than twice the resources as labour and capital than Firm B, than Firm A productivity is less than Firm B

PRODUCTIVITY - is a measure of the efficiency with which goods & services are produced Eg: Making same products and same equipment: In a 40hr week worker A produces 400 shoes/ worker B produces 600 shoes Worker A productivity=400 shoes/ 40 hrs= 10 shoes / hr Worker B = 600/ 40 hrs = 15 shoes / hr Bs productivity is more than A

Productivity in a firm will if more output can be produced with same input of resources OR same output but will less resources. If firm fails to increase productivity higher cost and lower profits make loss and products less competitive. Demand will drop and firms might fail. Production is a chain of economic activity linking many stages together from producing natural resources to selling finished products. In economics important we group firms and industries according to to the types of goods and services they provided.
DO EXERCISE 1 pp 207

Main different industries are divided into 3 groups:

Primary industries

Carry first stage of production Produce raw materials Example: Agriculture; Mining; forestry; quarrying; fishing

Secondary industries

Processing & manufacturing industries Change the raw material into finished or semifinished products Eg Steel; chemicals; furniture, clothing; footwear, cars

Tertiary industries

Provide services of all kind to Primary and secondary sectors. Also supply directly to consumers Need by all to function Eg: Banks; insurance; transportation; communications; hospital; schools. Also personal services such as hairdressers; tailors; gardeners; window cleaners
Do exercise 2 pp 209

The aims of production

1.

Aim of a firm is to make profit. Profit given to those who take risk. Firm need to incur cost first before selling finished products to earn any revenue.

Airbus from design to sales cost billions of pounds Dec 2000 8.8 billion programme for A380 Jan 2002 Started development on the wings. Prog to 11 billion April 2005 First test maiden flight June 2005 Delivery delayed 6 months June 2006 2nd delay of delivery for 6 7 months Share prices 25% of EADS. EADS and Airbus CEO with A 380 programme director resigned. Sept 2006 First flight with passengers Oct 2006 3rd delay Oct 2007 1st A380 delivered to SIA Dec 2007 Programme cost 15billion Present Delivered 36 out of 234 orders or 15%

Example

Profit = TR TC If TC is more than TR = LOSS

Other ways of making a LOSS: Fails to make a product that consumer wants At the price or quality that consumer wants Bad consumer service Unable to produce products at the same or cheaper cost than rival CRUCIAL firms to be efficient and continuous reduce their cost of production

2.

Providing a public service Using resources to provide services that people need and unable to afford. EG Education & Healthcare. Org are owned or funded by government Providing a charity Organisation rely on donations and endowments to provide help for people Non profit making organisations Local clubs or credit unions do things for members benefit.

3.

4.

Productivity & Factor Demand

Combining factors of productions either use labour intensive techniques use more labour than capital

Capital Intensive Using more plant and machinery relative to labour

Demand for labour & capital by a firm will depend on a number of factors:
1.

The amount of goods and services consumers demand More goods and services consumers want the more factors of production firms will tend to use Demand for factors of production is a derived demand depends on there being a demand for the goods and services they produce

2.

The price of labour and capital It is related to the price. As wages the demand for labour by firms will tend to contract. If the cost of buying or hiring capital , then demand for capital will also contract. If wages and cost of capital - firm might reduce labours and increase the use of machinery

3.

The productivity of labour and capital A profit max firm will only employ an extra amount of labour or capital if the value of output added is greater to the cost of employment in productivity of labour, the demand for labour

A firm will want to combine its resources in the most efficient way to maximize their overall productivity for the minimum of cost. If wages or the productivity of capital - a firm will tend to replace labour with more capital FACTOR SUBSTITUTION FACTOR SUBSTITUTION happens in modern industries such as automobile and high precision or clean rooms

Labour and Capital Not perfect substitutes Depends on type of product and production process used. newspaper, disc and cars Substitution of capital cannot be used for gardener, window cleaner, nurse but used capital equipment to assist. Now with high tech Japan is trying to use robots in health care industry or robots in cleaning. e,g robotic vacuum cleaner Others use total labour like furniture or personalized jewellery Substitute capital for labour may cost labour dispute possibility of strikes.

The IMPACT of Technology:

Disadvantage: Cause a fall in demand for labour. Eg Typesetters now replace with desktop publishing software Advantage: Tech advance brought many changes , products, new materials cause an increase in demand for labour in supplying advanced goods and services. e.g Western Digital or X Fab. Increase in comp technicians, electronic engineers, software engineers

Measuring the productivity of labour:

Average product of labour per period = Total output/ period Number of employees IT measure how efficient workers are.

But some are not measurable by output in service industry

Better way of measuring productivity is Average revenue per worker per period: = Total revenue per period Number of employees

But difficult to measure productivity in the service industry with no revenue. eg free hospital, schools and government departments To measure productivity, must measure quality of work and outputs as consumers willing to pay for better services and goods.

HOW CAN FIRMS THE PRODUCTIVITY OF LABOUR?

TRAINING WORKERS REWARDING EMPLOYEES WITH PERFORMANCE RELATED PAY AND BONUS EMPLOYEES HAVING SHARE OPTIONS (see Enron) IMPROVING JOB SATISFACTION BETTER WORK ENVIRONMENT, TEAMWORK AND MORE INTERESTING WORK GIVE MORE TOOLS AND EFFICIENT MACHINES FOR WORKERS LEAN MANUFACTURING NEW PROCESSES TO REDUCE WASTAGE , INCREASE SPEED, SAFETY, QUALITY E.G iso (International Org for Standardization) 9001Quality management systems audit and monitoring quality processes
FORWARD

ENRON

Enron was originally involved in transmitting and distributing electricity and natural gas throughout the United States. The company developed, built, and operated power plants and pipelines while dealing with rules of law and other infrastructures worldwide. Enron owned a large network of natural gas pipelines, which stretched ocean to ocean. In 1998, Enron moved into the water sector, creating the Azurix Corporation, which it part-floated on the New York Stock Exchange in June 1999. Azurix failed to break into the water utility market, and one of its major concessions, in Buenos Aires, was a large-scale moneyloser.

Enron grew wealthy due largely to marketing, promoting power, and its high stock price. Enron was named "America's Most Innovative Company" by Fortune for six consecutive years, from 1996 to 2001. I t was on the Fortunes "100 Best Companies to Work for in America" list in 2000, and had offices that were stunning in their opulence. Enron was hailed by many, including labor and the workforce, as an overall great company, praised for its large long-term pensions, benefits for its workers and extremely effective management until its exposure in corporate fraud.

The first analyst to publicly disclose Enron's financial flaws was Daniel Scotto, who in August 2001 issued a report to encouraged investors to sell Enron stocks and bonds at any and all costs. In August 2000, Enron's stock price hit its highest value of $90.20 At this point Enron executives, who possessed the inside information on the hidden losses, began to sell their stock. At the same time, the general public and Enron's investors were told to buy the stock. Executives told the investors that the stock would continue to climb to the $130 to $140 range. As executives sold their shares, the price began to drop. Investors were told to continue buying stock or hold steady if they already owned Enron because the stock price would rebound in the near future. CEO, Kenneth Lay's strategy for responding to Enron's continuing problems was in to calm investors and assure them that Enron was headed in the right direction. By August 15, 2001, Enron's stock price had fallen to $42. Many of the investors still trusted Lay and believed that Enron would rule the market. They continued to buy or hold their stock and lost more money every day. As

Lay has been accused of selling over $70 million worth of stock at this time, which he used to repay cash advances on lines of credit. He sold another $20 million worth of stock in the open market. Records show that Mrs. Lay placed the sale order sometime between 10:00 and 10:20 am. News of Enron's problems, including the millions of dollars in losses they had been hiding went public about 10:30 that morning, and the stock price soon fell to below one dollar. Former Enron executive Paula Rieker has been charged with criminal insider trading. Rieker obtained 18,380 Enron shares for $15.51 a share. She sold that stock for $49.77 a share in July 2001, a week before the public was told what she already knew about the $102 million loss.
BACK

How to decide firm size?

amount of output they produce revenue they earn Example: B Braun 4 billion number of people they employed : 40,000 amount of invested capital

Do exercise 4 pp 215

What FACTORS DETERMINE FIRM SIZE?? 1.

The size of the market may be small The market is local Local monopoly supply goods to a particular area A wide variety of goods and services are wanted small can cater to a variety of tastes and big firms hesitate to keep changing Luxury items are highly priced Only few people can buy certain items people like personal service small businesses like doctors, dentist, lawyer, hairdresser a large firm requires component parts small firms survive by producing parts for large manufacturer.

2.

Capital is limited usually use owner savings Government assistance Many start up loans for small firms Personal choice owner refusal to change structure and ownership.

3.

4.

HOW FIRMS CAN GROW IN SIZE??

1.

INTERNAL GROWTH Also called Organic growth Firm increasing its own scale of production Reinvest its profits Borrow from bank Or sale of shares

2.

TAKE OVER and MERGERS Take over or acquisition firm buys all or controlling interest of the shares of another company Holding company set up to hold interest in other companies Merger 2 or more firms agree to form a new enterprise. Exchanging shares in each company for new shares in the new company

Types of integration
1.

Horizontal This is the expansion of a firm within an industry in which it is already active for the purpose of increasing its share of the market for a particular product or service Same firms engaged in the production of same goods and services combine. Consolidation of services

Advantage: Economies of scale - average cost per unit to fall as the scale of output is increased Disadvantage: Might create a monopoly dominate the market and able to raise prices, reduce competition

Banking

2. Vertical Vertical integration is the degree to which a firm owns its upstream suppliers and its downstream buyers. Vertical integration is typified by one firm engaged in different parts of production (e.g. growing raw materials, manufacturing, transporting, marketing, and/or retailing).

1. Backward (upstream) vertical integration, when it controls subsidiaries that produce some of the inputs used in the production of its products. For example, an automobile company may own a tire company, a glass company, and a metal company. Control of these three subsidiaries is intended to create a stable supply of inputs and ensure a consistent quality in their final product. It was the main business approach of Ford and other car companies in the 1920s, who sought to minimize costs by centralizing the production of cars and car parts. 2. Forward (downstream) vertical integration when it controls distribution centers and retailers where its products are sold. 3 Balanced (both upstream and downstream) vertical integration. A firm controls all of these components, from raw materials to final delivery. Example SONY

There are three varieties:

3. Lateral This is growing by entering another industry altogether keeping the same brand. A firm which produces in different industries is sometimes called a Conglomerate Doing this spreads risk as demand in one industry cannot be guaranteed in the long term as new products may be switched to( MP3 market before iPod comes along for example).

Example Virgin Group Do exercise 5 pp 219

Banking system in Malaysia

1985 -1986 Banks with NPL. Bank Negara rescue and Finance Inst from 47 to 26 in 1999 Reasons that family run based bank cannot survive. Small malay bank cannot compete Bank Negara committed to make the merger a success RM60bill Banks merge from 21 in 1985 to 6 in 2000 The 10 anchor banks are Malayan Banking Bhd, Bumiputra-Commerce Bank Bhd, RHB Bank Bhd, Public Bank Bhd, Arab-Malaysian Bank Bhd, Hong Leong Bank Bhd, Perwira Affin Bank Bhd, MultiPurpose Bank Bhd, Southern Bank Bhd and EON Bank Bhd.

Malayan Banking - comprises Mayban Finance Bhd, Aseambankers Malaysia Bhd, PhileoAllied Bank Bhd, Pacific Bank Bhd, Sime Finance Bhd and Kewangan Bersatu Bhd. The Bumiputra-Commerce Bank Bhd leads the group of BumiputraCommerce Finance Bhd and Commerce International Merchant Bankers Bhd. RHB Bank Bhd will group RHB Sakura Merchant Bankers Bhd, Delta Finance Bhd and Interfinance Bhd. Public Bank Bhd, - Public Financ Bhd, Hock Hua Bank Bhd, Advance Finance Bhd and Sime Merchant Bankers Bhd The Arab Malaysian Bank Bhd will anchor Arab Malaysian Finance Bhd, Arab Malaysian Merchant Bank Bhd, Bank Utama Malaysia Bhd and Utama Merchant Bankers Bhd. Hong Leong Bank Bhd - Hong Leong Finance Bhd, Wah Tat Bank Bhd and Credit Corporation Malaysia Bhd.

Perwira Affin Bank Bhd leads Affin Finance Bhd, Perwira Affin Merchant Bankers Bhd, BSN Commercial Bank Bhd, BSN Finance Bhd and BSN Merchant Bank Bhd. now affin bank Multi-Purpose Bank Bhd will group International Bank Malaysia Bhd, Sabah Bank Berhad, MBf Finance Bhd, Bolton Finance Bhd, Sabah Finance Bhd, Bumiputra Merchant Bankers Bhd and Amanah Merchant Bank Bhd. Now Alliance Southern Bank Bhd will lead the group of Ban Hin Lee Bank Bhd, Cempaka Finance Bhd, United Merchant Finance Bhd, Perdana Finance Bhd and Perdana Merchant Bankers Bhd. Now merge with Bumiputra Commerce to form CIMB EON Bank Bhd, which will lead the banking group of EON Finance Bhd, Oriental Bank Bhd, City Finance Bhd, Perkasa Finance Bhd and Malaysian International Merchant Bankers Bhd Now talk on Hong Leong buying over EON

BACK

VIRGIN GROUP

Example: Virgin Group. 5.1billion 400 companies Early 70s: Richard Bransons powerhouse started with records In 1984 then came the airline In 2000 Virgin Media then the media now space travel! Linking fairly random industries has been an extreme success for Virgin. In 2010 F1 team too & AirAsia X (16%) In 2011 Virgin Galactic space travel $200000 with $20000 deposits Into hot air balloon; mobile; florist; money; radio; records; wines; vacations; music; drinks; clubs, airtravel
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