ECOMAN M13 Module 2

Chapter 2 focuses on firm production, revenue, and production cost, and how these concepts relate to production and cost analysis in both the short run and long run.

    Firm Production:

        Firm production refers to the process of converting inputs (resources) into output (goods or services).

        The production function represents the relationship between inputs and output, typically expressed as Q = f(K, L), where Q is the quantity of output, K is capital (e.g., machinery), and L is labor.

        The law of diminishing marginal returns states that as more units of a variable input are added to a fixed input, the marginal product of the variable input will eventually decrease.

    Revenue:

        Total revenue (TR) is the income a firm receives from selling its output, calculated as the product of quantity sold (Q) and the market price (P): TR = P * Q.

        Average revenue (AR) is the revenue per unit of output, calculated as AR = TR / Q.

        Marginal revenue (MR) is the change in total revenue from selling one additional unit of output.

    Production Cost:

        Production cost includes fixed costs and variable costs. Fixed costs remain constant regardless of the level of output, while variable costs change with the level of production.

        Total cost (TC) is the sum of fixed and variable costs: TC = FC + VC.

        Average total cost (ATC) is the cost per unit of output, calculated as ATC = TC / Q.

        Average variable cost (AVC) is the variable cost per unit of output: AVC = VC / Q.

        Marginal cost (MC) is the additional cost of producing one more unit of output.

Relation to Production and Cost Analysis in Short and Long Run:

    In the short run, at least one input is fixed, and firms can only adjust variable inputs. This leads to the concept of the short-run production function and cost curves. Firms choose the level of production that minimizes short-run costs.

    In the long run, all inputs are variable, allowing firms to make more extensive adjustments. This results in the long-run production function and cost curves. Firms aim to choose the optimal combination of inputs and scale of production to minimize long-run costs.

    Economies of scale occur when increasing production reduces the average cost per unit. Diseconomies of scale occur when further expansion leads to higher average costs. Constant returns to scale means that cost per unit remains constant with changes in production scale.

Understanding firm production, revenue, and production cost is crucial for making informed decisions about output levels and cost management, whether in the short run or long run. These concepts are fundamental for optimizing a firm's profitability and competitiveness in the market.

GENE SESE

MM-M13

In this module, we learned about the production function, which defines the relationship between the flow of inputs and outputs. Firms use inputs such as land, labor, capital, raw materials, and entrepreneurship and transform these into their products and services.

Companies then make decisions on what combination of inputs are to be used to and what is the maximum output to produce so that they may achieve their targets.

In this module we were also introduced to short run and long run production. The short run production refers to a company whose production relies on at least one fixed input. On the other hand, long run production is the scenario in which all inputs are variable. There are two main factors which cause companies to stay in the short run: they either do not have enough money or they are locked into long term contracts.

When companies are in the short run, there are multiple factors to consider when trying to maximize their revenue and profit. One of the most important concepts is the Law of Diminishing Returns. Here, we learned that “too many cooks spoil the broth”. Therefore, it’s important for businesses to understand where they can maximize their returns. Sometimes, not all business decisions that lead to additional revenue should be considered. Marginal revenue is the key to understanding which level of activities lead to better profit.

Some reflection from this module:

Productivity needs to be increased in order to make the organization more profitable. This can be done by through training, technology, and process changes. However, when increasing productivity, buy in from the organization is important. I have many experiences of trying to implement new tools and processes aimed at increasing productivity across departments in my previous firms. However, without proper buy in (which come from different levels - such as upper management, middle management, and from the staff themselves), all these fancy improvements were useless. The KPIs did not change. And my work was very much wasted. In hindsight, I could have done better by winning them over and making them understand how these changes could benefit them and make their lives easier.

Or, as prof said during this module, “Productivity, at the end of the day, is about people.”

Mary Acuna

Edward Sajo

MM-M13

Firms need to answer two questions.

What combination of inputs to use and what maximum output to produce.

A balance needs to be found in order to maximize profit.

Inputs can be Land, Labor, Capital (non-monetary) and Entrepreneurship.

These inputs are then categorized as either Fixed or Variable.

Having atleast ONE fixed input would put a company in the Short-run while having all variable inputs results to a Long-run.

Examples of short-run are an expensive investment in which a company buys a big machine to manufacture their goods.

Or a services company who signs a contract of lease of a building for 25 years.

In the present, investing in these items or agreeing to these terms may seem like a good idea, but with the ever dynamic market, a company has to be agile in order to adapt to the market changes.

Companies need to maximize their employees productivity in order to increase profits.

Its either that or cut wages or terminate employees.

For me, I would rather work on getting the employees' productivity up.

Increasing productivity can lower costs which results to higher profit.

Below are the different types of costs and profits:

Explicit costs are traditional out-of-pocket costs; price of raw materials, labor etc.

Implicit costs are indirect opportunity costs;price of intangible things that we give up in favor of the selected option

Variable cost are costs that change with the amount produced

Fixed costs are costs that remain constant regardless of the change in amount produced

Average cost is the cost per unit; the total cost divided by the number of output

Accounting profit = Revenue - Explicit costs

Economic profit = Revenue - Explicit costs - Implicit costs

When you are a big firm, you are able to take advantage of the economies of scale.

You can buy raw materials in bulk in order to get a discounted rate.

You can get lower interest rates in bank loans due to the company's size and lower risk factor.

Advertising costs can be spread out since the company has more than one product that can generate revenue.

However, if a firm becomes too large, it might experience the diseconomies of scale.

Too much specialization and division of labor can lead to dull and routinary jobs that may cause dissatisfaction with the employees.

Depending on foreign talent can lead to higher wage costs.

It is not a guarantee that diseconomies of scale will be an outcome when a company expands.

The point at which diseconomies of scale start to outweigh economies of scale will vary from one organization to another, depending on its specific circumstances and management practices.

Companies need to carefully manage their growth and consider the potential challenges that may arise as they expand to ensure that they continue to operate efficiently and profitably.

Short Run Production – this a scenario where there is at least 1 fixed input. The primary concern of having a short run production is that a business is limited to its optimum productivity level. Once its operations have reached its optimum productivity level, it is no longer ideal for the firm to further increase in manpower or equipment as productivity level gradually decreases as the firm exceeds its optimum production. Diseconomies of scale start to take effect when this happens.

Long Run Production – All inputs in the production line are variable and can be adjusted by the firm at any given time. This model is primarily used by larger organizations that has a large scale of operations. Most firms that have this model can leverage on economies of scale due to the bandwidth and capacity of their production lines. Although having a long run production does not directly result to economies of scale as the firm manages several inputs that needs to be adjusted. If not analyzed well, this can also result to disruption within the operation also affecting the firm’s profitability. Further expansion of operation also involves significant costs for the firm such as capital, manpower, equipment, training, and development, etc..

From analysis, productivity is measured not just in the capacity of the variables involved including the profitability of each adjustment.

Economics also analyzes different cost structures:

1. Explicit costs are costs that are recorded by the book, mainly monitored by accountatns.

2. Implicit costs are unrecorded costs and difficult to measure, can also be considered as opportunity cost or sometime R&D.

-Isidro, Gerard Benjohn P.

MM, M13

CIRILO A. MONSANTO

MM-M13

PRODUCTION & COST ANALYSIS IN THE SHORT-RUN:

In the short-run, certain factors of production remain fixed, leading to constraints on the extent to which output can be adjusted. This period witnesses variable costs changing with the level of production, while fixed costs remain constant. It's intriguing to see how businesses can face diminishing returns in the short run, meaning that after a certain point, each additional unit of the variable input results in smaller increases in output. This phenomenon affects cost structures, with the cost per unit potentially rising after a certain level of production. As a business manager, it's crucial to be aware of this inflection point to optimize production levels and manage costs effectively. The concept of the shutdown point, where it makes more economic sense to halt production rather than continue, is also vital to understand and can be instrumental in decision-making during economic downturns or market challenges.

PRODUCTION & COST ANALYSIS IN THE LONG-RUN:

In the long-run, all factors of production become variable, offering businesses more flexibility in their operations. This timeframe allows firms to adjust their scale of operations, leading to potential economies or diseconomies of scale. A significant insight here is understanding that, as firms expand, they might initially benefit from reduced costs per unit due to economies of scale. However, after a certain point, they may face diseconomies of scale, where expanding further could lead to increased per-unit costs. This can be due to challenges in managing larger operations, increased bureaucracy, or communication inefficiencies. Therefore, it's paramount to strike a balance and identify the optimal scale of operation. The long-run also provides businesses the opportunity to evaluate and alter their production processes, invest in new technologies, or enter/exit market segments based on projected costs and potential returns.

While the short-run focuses on optimizing within existing constraints, the long-run offers a broader perspective, allowing for significant structural changes and strategic shifts. Both timeframes provide valuable insights, and understanding the nuances of each can lead to more informed and effective decision-making in business.

OPPORTUNITY COST:

When making decisions, it's essential to consider not just the explicit costs but also the opportunity costs. For instance, a lawyer who opens a pizza parlor might earn less than he would practicing law, but he might be happier running the pizza shop.

TYPES OF PROFIT:

Accounting Profit: Revenue minus explicit costs.

Economic Profit: Revenue minus both explicit and implicit costs.

Economic vs. Accounting Profit: In competitive markets, companies might make an accounting profit but no economic profit. This is because they're not earning above their opportunity costs.

COST OF PRODUCTION:

Variable Costs - Costs that change with the amount produced.

Fixed Costs - Costs that remain constant regardless of the production volume.

ECONOMIES OF SCALE:

Larger companies often have a cost advantage over smaller ones because they can spread out their fixed costs over a larger number of units.

MARGINAL COST AND REVENUE:

To maximize profit, a company should produce where the marginal revenue (additional revenue from selling another unit) equals the marginal cost (additional cost of producing another unit).

LAW OF DIMINISHING MARGINAL RETURNS:

As more of a variable resource is added to a fixed resource, the additional output generated from each additional unit will eventually decrease.

SUNK COST:

Costs that have already been incurred and cannot be recovered. These costs should not influence future decisions.

BEHAVIORAL ECONOMICS:

People often make irrational decisions by not considering sunk costs. For instance, staying in a relationship because of the time invested, even if it's not beneficial for the future.

BALANCING COSTS AND BENEFITS:

Understanding the law of diminishing returns and the concept of sunk costs can help individuals and businesses make more informed and rational decisions.

Module 2 Key Insights

Economics has different ways of recognizing costs. It includes opportunity cost in computing profits, unlike accounting profits.

2 types of Profit

1. Accounting Profit = revenue minus explicit cost (traditional costs in running a business)

2. Economic Profit = revenue minus the explicit and implicit cost (indirect opportunity cost)

The minimum level of economic profit a company needs to stay in business is the Normal Profit.

Cost of Production – the actual cost of producing things

Concept of Costs

1. Explicit Cost – recorded in a firm’s accounting system ex.: Salaries, raw materials payment

2. Implicit Cost – same as opportunity cost, difficult to measure and not recorded in the balance sheet ex.: time, other opportunities

Companies that produce more can utilize mass production, as the cost can be spread over a larger amount of goods this is called Economies of Scale.

Understanding the relationship between production and cost is essential to determining pricing strategies, profit maximization, and resource allocation in a competitive market. Furthermore, businesses aim to produce at a level where their costs are minimized.

DELIA TABONIAG

MM-M13

Production and Cost Analysis in the Short-run

1. Every production process requires a combination of various inputs to generate outputs. The efficiency of this conversion can determine the success of a business.

2. Flexibility Matters- The distinction between fixed and variable inputs highlights the importance of flexibility in business operations.

3. Short-run Limitations- Even though the short-run can extend over a significant period, it has inherent limitations due to at least one fixed input. This can lead to inefficiencies.

4. Productivity is Key- Metrics like Average Product (AP) and Marginal Product (MP) are essential indicators of a firm's efficiency/productivity.

5. The law of diminishing marginal returns is a fundamental economic principle. After a certain point, adding more of a variable input will produce less additional output, which can inform decisions about resource allocation.

6. Cost Awareness- Being aware of both explicit and implicit costs ensures a comprehensive understanding of the business's expenses.

7. Profit isn't just Revenue- Economic profit takes into account both explicit and implicit costs, providing a more holistic view of a business's performance than accounting profit.

8. Short-run Challenges- The issues that arise in short-run production, like overcrowding and communication breakdowns, emphasize the need for efficient management and forward planning.

9. Managerial Tips - Monitoring KPIs, understanding capacity utilization, and investing in training are crucial for efficient business operations.

10. Opportunity Costs- Every business decision has an associated opportunity cost. Recognizing and evaluating these costs is important in making informed decisions.

Production and Cost Analysis in the Long-run

1. In the long run, all inputs, including labor and capital, can be adjusted, providing firms with greater flexibility in their production decisions.

2. Input Substitution- The ability to replace one input with another in response to changes in relative prices is crucial.

   a. If wages rise, firms might opt for more capital-intensive methods, potentially leading to unemployment.

   b. If the cost of capital (like rent or tariffs) increases, firms might lean towards more labor-intensive methods.

3. Market Dynamics and Input Choices-

   a. In a competitive market, firms are more driven to minimize costs, leading them to continuously evaluate their mix of inputs.

   b. In less competitive environments, firms might have less urgency to find the most cost-effective combination of inputs, leading to potential X-inefficiency.

4. Lean production emphasizes efficiency and waste reduction.

5. Cost Optimization- In the long run, firms aim to equalize the marginal product per dollar spent across all inputs. This ensures they're getting the best possible return on their input investments.

6. Long-Run Average Cost (LRAC)- This curve shows the minimum average cost of production at different levels of output when all inputs are variable. It reflects economies and diseconomies of scale.

7. Economies of Scale- As firms expand production, they can benefit from:

   a. Specialization and division of labor

   b. Technological advancements

   c. Automation

   d. Bulk purchasing discounts

   e. Spreading fixed costs, like advertising, over a larger number of units

   f. Financial advantages, such as lower interest rates

8. Diseconomies of Scale- Beyond a certain point, expanding production can lead to increased per-unit costs due to:

   a. Challenges in managing large-scale operations

   b. Monotony leading to decreased worker efficiency

   c. The need to pay higher wages for specialized or foreign work

   d. Centralized costs

   e. Increased transportation costs

Isabel Patricia J. Mora