The production function considered earlier establishes a natural-material (technological) connection between the use (costs) of production factors and the volume of output. In this question we will talk about cost the relationship between the volume of production and the input factors of production.
Production costs (WITH) is the cost of the factors of production used. The amount of costs depends on the volume of resources expended and their price. However, since resources are limited, their use for production of this product means refusing to produce other, alternative products. Hence: all production costs are by nature alternative, those. they are associated with missed opportunities to use resources in other production.
The steel used in the production of cars will be lost for the production of machines, tools, etc. If a mechanic is employed in the production of the same automobile, the cost associated with using the labor of that mechanic in the automobile plant is equal to the contribution that he could make in the production of refrigerators.
There are external and internal production costs.
External(monetary, explicit) costs– opportunity costs, which take the form of cash payments made by the firm to suppliers of factors of production (wages of workers and employees, costs of raw materials and supplies, rent, etc.). These are payments made in order to attract limited resources specifically in this production and thereby leading to the diversion of these resources from other alternative options their applications.
Domestic(implicit, implicit) costs- these are monetary incomes that the company sacrifices, independently using its resources, i.e. this is the income that could be received by the company for independently used resources (cash, premises, equipment, etc.) with the best of possible ways their applications.
For example, if a company is located in premises owned by the owner of the company, then the opportunity to rent out this premises and receive rent is missed. Although internal costs are implicit, hidden in nature and are not reflected in financial statements, they must always be taken into account when making economic decisions, i.e. lost (not received) in in this example rent is part of the economic cost of production.
Internal costs also include the so-called normal profit. Normal profit represents the minimum fee with which entrepreneurial ability should be rewarded in order to stimulate its use in a given firm, i.e. This is the minimum income that an entrepreneur must receive in order to remain in this business. This income should be no less than the profit that the entrepreneur could have in another, most profitable field of activity for himself, but is “lost” by him. Almost normal profit is determined by the entrepreneur himself as an assessment of alternative opportunities for applying his entrepreneurship.
Thus, economic costs include both external and internal (including normal profit) costs, while accounting costs include only external ones.
Since the amount of accounting and economic production costs does not coincide, there are also differences in the amount of accounting and economic profit.
Accounting profit equal to revenue from sales of products minus accounting (external, explicit) production costs.
Net economic profit equal to sales revenue minus economic production costs (external and internal, including normal profit).
The ability to change production methods and costs varies depending on how long it takes a firm to change production technology or respond to changes in market conditions. This fact is reflected in the existence of differences between production costs in the short and long term.
Short term – This is a period when most of the factors of production remain constant, fixed, and in order to increase (or reduce) the volume of production the firm can change only one factor of production. IN short term Such types of costs as buildings, equipment, crop areas remain constant, so the company can influence the volume of production by changing only, for example, the number of employees involved.
In the long run the company may make changes to All factors of production. It can not only hire additional workers, but also expand its production capacity through construction or acquisition additional premises and equipment, which will allow production of products on a scale that will best suit new market conditions.
When analyzing costs, it is necessary to distinguish costs for the entire volume of output - full(total, total) production costs – and unit production costs – average(unit) costs.
Considering the costs of the entire volume of output, the following production costs are distinguished:
permanent (F C) – costs that do not depend from the volume of output ( Q) and arise even when production has not yet begun. Thus, even before production begins, the enterprise should have at its disposal such factors as buildings, machines, and equipment. In the short term, fixed costs are rent, security costs, property taxes, etc.;
variables (VC) – costs that are changing depending on the volume of output. These include: basic and auxiliary materials, workers' wages, transportation costs, electricity costs for production purposes, etc.;
cumulative (TS) – the sum of fixed and variable costs:
TC =FC+V.C.
Variable and total production costs increase along with an increase in output, but the growth rate of these costs is not the same. Starting from scratch, as production increases, they initially grow very quickly, then as production volumes continue to increase, their growth rate slows down and they grow slower than production (positive economies of scale). Subsequently, however, when the law of diminishing returns comes into play, variable and total costs begin to outpace production growth (Figure 7.3).
Rice. 7.3. Production costs of the entire output
Cumulative (TC), variable ( V.C.) and fixed costs ( F.C.)
For economic analysis, of particular interest are costs per unit of output, or average costs:
average fixed costs (A.F.C.) – fixed costs per unit of production:
A.F.C. = F.C.: Q.
As production volume increases, fixed costs are distributed over more products, so that average fixed costs decrease;
average variable costs (AVC) – variable costs per unit of production:
AVC=V.C.: Q.
As production volume increases, average variable costs first fall (positive economies of scale), reach their minimum, and then, under the influence of the law of diminishing returns, begin to rise.
average total costs (ATS)– total costs per unit of production:
ATS = TS:Q.
The dynamics of average total costs reflects the dynamics of average fixed and variable costs. While both are decreasing, the average total costs are falling, but when, as production volume increases, the growth of variable costs begins to outpace the fall in fixed costs, the average total costs begin to rise.
IN economic analysis widely used marginal cost (MS) – increase in costs as a result of producing one additional unit of product:
MS =Δ TS: Δ Q
Marginal cost shows how much it would cost the firm to increase output per unit. Marginal costs have a decisive influence on the firm's choice of production volume, because this is precisely the indicator that the firm can influence (Fig. 7.4).
Rice. 7.4. Production costs per unit
Limit (MS), average constants – (AFC), average variables –
( AVC), average total – (ATC) production costs
Above we discussed the dynamics of production costs associated with changes in output volume at this level fixed costs. In the long run, a firm can change All factors of production used. If a firm reaches a production volume at which marginal costs increase sharply, then it is forced to make changes to those factors of production that were previously constant, i.e. in the long run All production costs are variable.
Production costs, which characterize the costs of production factors per unit of output in the long run, are called long-term average costs (LAC). The dynamics of long-term average costs and, accordingly, the shape of their curve are influenced by the effect of scale.
Depending on the ratio of the growth rate of production costs and production volume, the following are distinguished:
increasing(positive) returns to scale - production volume grows faster than costs, and therefore average production costs decrease;
decreasing(negative) returns to scale - costs grow faster than production volume, and therefore average production costs increase;
constant returns to scale - production volume and costs grow at the same rate, respectively, the cost of production per unit of output does not change.
See also:
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Economy. P. SAMUELSON. ECONOMY. Volume I. Circulation 25,000 copies. |
Running any business involves certain costs. One of the basic laws of the market is that you need to invest something in order to get something. Even if an organization or entrepreneur sells the result of its own intellectual activity, it still incurs certain costs. This article discusses what costs are, what they are, the differences between external and internal costs, as well as formulas for calculating them.
What are costs?
This concept is applicable in all areas entrepreneurial activity. Costs are the organization’s expenses for its needs, ensuring production activities, communal payments, employee salaries, advertising costs and much more. External and internal costs, their correct calculation and analysis are the key to stable operations and financial security of enterprises. In the process of conducting commercial affairs, it is necessary to take a sober look at the capabilities and needs of the organization, optimally select the set of purchased services and products, trying to minimize expenses and maintain their level below the profit level.
Terminology, or What are costs called?
Economics is a science with a very large number of branches, each of which studies its own individual phenomena. Each direction has its own ways of collecting and processing information, as well as methods of documenting the results. Because of large quantity various reports used by different specialists, but carrying essentially identical information, there is some uncertainty in terminology. Thus, the same phenomena can be completely different names. So they can different types documents are found under different names: internal and external costs. These names are presented below:
- accounting and economic;
- explicit and implicit;
- explicit and implied;
- external and internal.
By their nature, all these names are identical to each other. Familiarity with this fact will help you avoid confusion in the future when processing various documents in which these names appear.
External costs are...
Organizations in the course of work purchase raw materials, materials, machines and equipment, pay for the labor of service personnel and specialists, pay utility bills for consumed water, energy, use land plot or the area of office buildings. All these payments are external costs. This is the alienable part Money organization in favor of the supplier required product or services. In this case, the supplier is a third party organization that is not related to this company. Also, these payments may be referred to in various documents and reports as accounting or explicit costs. It all has one characteristic feature- such payments are always reflected in accounting with an exact indication of the date, amount and purpose.
Internal costs
We discussed above what external costs are. Economic costs, also known as internal, implicit or implied, are the second type of expenses taken into account in reporting and analysis. With them everything is a little more complicated. Unlike obvious costs, this is a waste of your own resources, rather than purchasing them from a third party. And the amount that is considered expenses in this case is the amount that could have been received by the organization if it had used the same resources in the most optimal and profitable way. The use of this type of expense is not used in accurate and documented accounting. But economists actively operate on implicit costs, whose tasks include assessing the efficiency of an organization over past periods, planning and drawing up business models for future production processes, as well as optimizing all areas of activity of a commercial company.
Subtypes of external costs
The production process requires investment in its various components, without which the mechanism for producing products or providing services simply will not function. A firm's external costs are classified depending on how their price will contribute to the final cost of the product produced or service provided. The identified types of external costs are:
- Fixed costs are expenses, the amount of which is included in equal shares in the cost of a product or service over a certain period of time. They do not change due to an increase or decrease in production volumes. An example of such costs is wages employees holding administrative positions, or payment for rent of office, warehouse and production premises.
- Average fixed costs are expenses that also do not change over a short period of time. However, in the case of average fixed costs, the dependence on the volume of products produced or services performed can be traced. At larger volume production costs are reduced.
- Variable costs are expenses that directly depend on the volume of products produced. So, the more goods were produced, the more it is necessary to pay for raw materials, the labor of workers receiving piecework wages, and the supply of energy resources.
- Average variable costs are the amount of money spent on paying variable costs for producing a unit of output.
- Total costs are the result of adding constant and variable expenses, reflecting big picture expenses for the functioning of the organization and production activities for a certain period of time.
- Average total costs are an indicator of how much money from the total amount of expenses falls on one unit of output.
Features of variable expenses
What costs are called external variables? The volume of which changes along with the volume of products produced. Only fluctuations in the amounts of variable expenses are not always linear. Depending on the reason and method of change in production volumes, costs can change in three predictable ways:
- Proportional. With this type of change, the amount of costs changes in the same proportion with the volume of production. That is, if a company produced 10% more products in this period, costs also increased by 10%.
- Regressive. The amount of costs spent on production grows more slowly than the volume of production. For example, a company produces 10% more goods, but costs have increased only by 5%.
- Progressive. Production costs are growing faster than production volumes themselves. That is, the company produced 20% more products, and costs increased by 25%.
The concept and significance of the period in cost calculation
Any calculations, analytical and reporting activities, as well as planning are impossible without the concept of a period. Each organization develops and operates at its own pace, so there is no clear time period that is the same for all firms. The decision about what period of time to use as the reporting period is made in each specific organization. However, these numbers are not taken out of thin air. They are calculated depending on many external and internal factors.
Time is a factor that is given great value when calculating profits and expenses. An analysis of the growth of production activity or its deterioration, profitability or unprofitability can be carried out only on the basis of its final indicators for several reporting periods. Data are usually considered separately for short-term and long-term periods.
Costs in long and short periods
The short-term period may vary in duration for organizations in different industries. General rules to establish it - in the short term, one group of production factors is stable, the other can change. The land, production space, number of machines and pieces of equipment remain constant. The number of employees and their wages, purchased materials and raw materials, and so on may change.
Long-term planning is characterized by the adoption of all factors of production and their costs as variables. During this time, the organization can grow or, conversely, decrease, change the number and composition of employees in staffing table, change the actual and legal address, purchase equipment, and so on. Long-term planning is always more complex and deeper. It is necessary to predict the dynamics of development as accurately as possible in order to stabilize the company’s position in the market.
Cost calculation formula
In order to find out how much money an organization spends to maintain production activities, there is a formula for external costs. It is depicted like this:
- TC=TFC+TVC, where:
- TC - abbreviation for in English- Total Costs - total amount expenses for the production of products and the functioning of the organization;
- TFC - Total Fixed Costs - the total amount of fixed costs;
- TVC - Total Variable Costs - the total amount of variable costs.
In order to find out the amount of external costs per unit of goods, an example of a formula can be given as follows:
- ATC=TC/Q, where:
- TC - total amount of expenses;
- Q is the volume of goods produced.
Costs(cost) - the cost of everything that the seller has to give up in order to produce the goods.
To carry out its activities, the company incurs certain costs associated with the acquisition of necessary production factors and the sale of manufactured products. The valuation of these costs is the firm's costs. Most economically effective method production and sale of any product is considered to be such that the company’s costs are minimized.
The concept of costs has several meanings.
Classification of costs
- Individual- costs of the company itself;
- Public- the total costs of society for the production of a product, including not only purely production, but also all other costs: protection environment, training of qualified personnel, etc.;
- Production costs- these are costs directly associated with the production of goods and services;
- Distribution costs- related to the sale of manufactured products.
Classification of distribution costs
- Additional costs circulation includes the costs of bringing manufactured products to the final consumer (storage, packaging, packing, transportation of products), which increase the final cost of the product.
- Net distribution costs- these are costs associated exclusively with acts of purchase and sale (payment of sales workers, keeping records of trade operations, advertising costs, etc.), which do not form a new value and are deducted from the cost of the product.
The essence of costs from the perspective of accounting and economic approaches
- Accounting costs- this is a valuation of the resources used in the actual prices of their sale. The costs of an enterprise in accounting and statistical reporting appear in the form of production costs.
- Economic understanding of costs is based on the problem of limited resources and the possibility of their alternative uses. Essentially all costs are opportunity costs. The economist's task is to choose the most optimal option for using resources. The economic costs of a resource chosen for the production of a product are equal to its cost (value) under the best (of all possible) use case.
If an accountant is mainly interested in assessing the company’s past performance, then an economist is also interested in the current and especially projected assessment of the firm’s performance, searching for the most optimal option use of available resources. Economic costs are usually greater than accounting costs - this is total opportunity costs.
Economic costs, depending on whether the firm pays for the resources used. Explicit and implicit costs
- External costs (explicit)- these are the costs in cash that the company makes in favor of suppliers of labor services, fuel, raw materials, auxiliary materials, transport and other services. In this case, the resource providers are not the owners of the firm. Since such costs are reflected in the balance sheet and report of the company, they are essentially accounting costs.
- Internal costs (implicit)— these are the costs of your own and independently used resource. The company considers them as the equivalent of those cash payments that would be received for an independently used resource with its most optimal use.
Let's give an example. You are the owner of a small store, which is located on premises that are your property. If you didn’t have a store, you could rent out this premises for, say, $100 a month. These are internal costs. The example can be continued. When working in your store, you use your own labor, without, of course, receiving any payment for it. With an alternative use of your labor, you would have a certain income.
The natural question is: what keeps you as the owner of this store? Some kind of profit. The minimum wage required to keep someone operating in a given line of business is called normal profit. Lost income from the use of own resources and normal profit in total form internal costs. So, from the standpoint of the economic approach, production costs should take into account all costs - both external and internal, including the latter and normal profit.
Implicit costs cannot be identified with the so-called sunk costs. Sunk costs- these are costs that are incurred by the company once and cannot be returned under any circumstances. If, for example, the owner of an enterprise incurs certain monetary expenses to have an inscription made on the wall of this enterprise with its name and type of activity, then when selling such an enterprise, its owner is prepared in advance to incur certain losses associated with the cost of the inscription.
There is also such a criterion for classifying costs as the time intervals during which they occur. The costs that a firm incurs when producing a given volume of output depend not only on the prices of the factors of production used, but also on which ones. production factors are used and in what quantity. Therefore, short- and long-term periods in the company’s activities are distinguished.
In Fig. 19.6, the producer surplus is shown by the shaded area between the demand (price) curve - C (P) and the marginal cost curve P prev. At output level QBC, the marginal cost curve and the demand (price) curve intersect at point B. Consequently, the last unit of output does not produce a surplus, since the price is equal to the marginal cost of the last unit of this output (point B).
Rice. 19.6. Producer surplus
Due to the fact that fixed costs do not depend on production volume, the sum of all marginal costs must be equal to the total variable costs of the enterprise.
Therefore, the producer surplus - the shaded triangle AOB - can alternatively be represented by the rectangle ABCD as the difference between the gross income of the enterprise (OABQ BC) and the sum of its marginal costs (ATC Q BC). Triangle ODE, according to all the signs of equality of triangles, is equivalent in area to triangle BCE.
Costs in the long run
When considering costs in the long term, it should be recalled that in this case all costs become variable due to periodic changes in production conditions as a result of investment activity. Therefore, in the long term, separate analysis of fixed and variable costs becomes meaningless. However, the analysis of total average costs remains important. A feature of the long-run average cost curve is that it is formed by integrating short-term average total costs as we move from one scale of production to another. Consequently, the long-term average total cost curve is a chain of sequentially interconnected short-term cost curves of this kind (Fig. 19.7).
Rice. 19.7. Long-run production costs
The long-run average total cost curve is also called the enterprise selection curve. It runs tangent to infinite number short-run average total cost curves. Depending on the nature of the technical, organizational and economic activities carried out, and the scale of production, the long-term average total cost curves take different kind. The laws of increasing, constant and decreasing productivity have a decisive influence on the nature of the curve.
conclusions
1. Production costs are the totality of costs associated with the production of products. They are divided into external and internal, constant and variable.
2. The basis for distinguishing costs into external and internal are the criteria for the ownership of the resource used. If a resource is the property of an enterprise (entrepreneur), then its costs are classified as internal costs, but if the enterprise buys a resource, then its costs are classified as external costs. Internal costs also include compensation for the entire total effort and risk of the entrepreneur in the form of normal profit.
3. Distinguish between accounting and economic profit. Accounting profit equals the difference between gross income (total revenue) and external costs. Economic profit is the difference between gross income and the sum of internal and external costs (total costs). Therefore, accounting profit is greater than economic profit by the amount of internal costs.
4. In the short term, production costs are divided into fixed and variable. The criterion for classifying costs as constant or variable is their response to changes in production volume. If, when the volume of output changes, the value of certain costs remains unchanged, then we're talking about about fixed costs. If costs change along with changes in the volume of output, then we are talking about variable costs. In sum, fixed and variable costs form total costs.
5. Production costs per unit of production are called average costs. Average costs are variable, fixed and total. They are calculated by dividing variable, fixed and total costs, respectively, by the volume of production associated with these costs. However, average cost must be distinguished from marginal cost, which is also associated with unit output. If average costs indicate what costs are incurred on average per unit of output at given volume production, then marginal costs indicate the costs associated with the production of each additional unit of production in relation to the existing volume of production.
6. In the long run, all costs become variable, since changes occur not only in production itself as a result of investment activity, but also in business conditions, i.e. changes in the economic environment itself for the use of production factors.
Economic costs
Economists' understanding of costs is based on the fact that resources are scarce and the possibility of alternative uses. Therefore, the choice of certain resources for the production of a certain good means the impossibility of producing some alternative good. Costs in the economy are directly related to the denial of the possibility of producing alternative goods and services. More precisely, the economic, or opportunity, cost of any resource chosen to produce a good is equal to its best-case value, or value. possible options use. This concept of costs is clearly embodied in the production possibilities curve discussed in Chapter 2. Notice, for example, that at point C (see Table 2-1) the opportunity cost of production is 100 thousand. additional pizzas are equal to the cost of 3 thousand industrial robots, which will have to be abandoned. Steel used to make weapons will be lost to making cars or building homes.
And if a worker on an assembly line is able to produce
both cars and washing machines, the cost incurred by society in employing this worker in the automobile plant will be equal to the contribution he would otherwise be able to make to production washing machines. The costs you incur in reading this chapter depend on the alternative uses of your time that you will have to forego accordingly.
EXTERNAL AND INTERNAL COSTS
Let's now look at costs from the perspective of an individual firm. Based on the concept of opportunity costs, we can say that economic costs are those payments that a firm is obliged to make, or those revenues that a firm is obliged to provide to a supplier of resources in order to divert these resources from use in alternative production. These payments can be either external or internal. Cash payments - that is, monetary expenses that a firm incurs "out of its own pocket" in favor of "outsiders" supplying labor services, raw materials, fuel, transportation services, energy, etc. - are called external costs. In other words, external costs represent payments for resources to suppliers who do not belong to the owners of the firm. However, in addition, the firm can use certain resources that belong to it. From the concept of opportunity costs, we know that regardless of whether a resource is owned or hired by the enterprise, a certain way of using that resource is associated with some costs. The costs of owning and independently using a resource are unpaid, or internal, costs. From the firm's point of view, these internal costs are equal to the monetary payments that could be received for the independently used resource if it were used in the best possible way.
Example. Suppose Mrs. Brooks is the sole owner of a small grocery store. She has full ownership of the store premises and uses her own labor and money capital in it. Although the enterprise has no external costs for paying rent and wages, internal costs
supports of this kind still exist. Using your own premises for the store, Mrs. Brooks sacrifices the monthly rental income of $800, which she would otherwise receive by renting out the premises to someone else. Similarly, using his own money capital and labor in his enterprise, Brooks sacrifices interest and wages, which it could obtain by ensuring that these resources are put to the best possible use. Finally, by running her own business, Brooks forgoes earnings that she could have made by offering her management services to some other firm.
NORMAL PROFIT
AS AN ELEMENT OF COST
The minimum payment required to retain Mrs. Brooks's entrepreneurial talent in a given enterprise is called the normal profit. Its normal reward for performing entrepreneurial functions is an element of internal costs along with internal rent and internal wages. If this minimum or normal reward is not provided, the entrepreneur will redirect his efforts from this area of activity to another, more attractive one, or even abandon the role of entrepreneur in order to receive a salary or salary.
Briefly speaking, economists consider all payments to be costs- external or internal, including the latter and normal profit,- necessary to attract and retain resources within a given area of activity.
LAW OF DIMINING RETURN
In its most general form, the answer to this question is given by the law of diminishing returns, which is also called the “law of diminishing marginal product” or the “law of varying proportions.” This law states that, starting from a certain point, the successive addition of units of a variable resource (for example, labor) to a constant, fixed resource (for example, capital or land) gives a decreasing additional, or marginal, product per each subsequent unit of the variable resource.
In other words, if the number of workers servicing a given piece of machinery increases, then the growth in output will occur more and more slowly as more workers are involved in production.
To illustrate this law, we give two examples.
Logical explanation. Imagine that a farmer has a fixed amount of land - say 80 acres - on which to grow crops. Assuming that the farmer does not cultivate the soil at all, the yield from his fields will be, for example, 40 bushels per acre. If the soil is worked once, the yield can rise to 50 bushels per acre. A second tillage may increase the yield to 57 bushels per acre, a third to 61, and a fourth to, say, 63. Further tillage will produce little or no increase in yield. Subsequent cultivation contributes less and less to the productivity of the land. If things had been different, the world's grain needs could have been met by extremely intensive cultivation of this eighty-acre plot of land alone. Indeed, if diminishing returns did not occur, the entire world could be fed with the harvest from a single flower pot.
The law of diminishing returns also applies to non-farm industries. Imagine a small carpentry shop making wooden frames for furniture. The workshop has a certain amount of equipment - turning and planing stakes, saws, etc. If this firm hired only one or two workers, its overall output and productivity level (per worker) would be very low. These workers would have to perform a range of different jobs, and the benefits of specialization would not be realized. Besides, work time would be lost every time a worker moves from one operation to another, and the machines would stand idle for a significant part of the time. In short, the workshop would be understaffed with workers, and production would therefore be inefficient. Production would be inefficient due to an excess of capital relative to labor. These difficulties would disappear By as the number of employees increases. Equipment would be more fully utilized, and workers could specialize in specific operations. As a result, time wasted during the transition from one operation to another would be eliminated. Thus, as the number of workers in an understaffed enterprise increases, the incremental, or marginal, product produced by each successive worker will tend to increase due to increased production efficiency. However, this cannot continue indefinitely.
A further increase in the number of workers will create a problem of their surplus. Now workers will have to stand in line to use the machine, i.e. workers will be underutilized. The total volume of production will begin to grow at a slowing pace, since with fixed production capacity there will be less equipment per worker, the more workers are hired. The additional, or marginal, product of additional workers will decrease as the enterprise becomes more and more intensively staffed. Now there will be more labor in it in proportion to the constant amount of capital funds. Ultimately, the continued increase in the number of workers in the enterprise would lead to them filling the entire free space and to stop the production process.
It should be emphasized that the law of diminishing returns is based on the assumption that all units variable resources- all workers in our example are qualitatively homogeneous. That is, it is assumed that each additional worker has the same mental abilities, coordination of movements, education, qualifications, work skills, etc. The marginal product begins to decrease not because workers hired later are less skilled, but because relatively more are employed for the same amount of capital funds available.
Numerical example. Table 24-1 provides a clearer numerical illustration of the law of diminishing returns. Column 2 shows the total quantity of output that can be obtained from the combination of each quantity. labor resources, taken from column 1, with capital funds, the value of which is assumed to be constant. Column 3 (marginal productivity) shows change total production volume associated with each additional investment labor. Note that if there is no labor input, output is zero; An enterprise without people will not be able to produce products. The appearance of the first two workers is accompanied by increasing returns, since their marginal products are 10 and 15 units, respectively. But then, starting with the third worker, the marginal product - the increase in total production - successively decreases, so that for the eighth worker it is reduced to zero, and for the ninth it becomes negative. Average productivity, or output per worker (also called labor productivity). shown in column 4. It is calculated by dividing the output (column 2) by the corresponding number of workers (column 1).
Graphic image . Figures 24-2a and 26 depict the law of diminishing returns graphically, which is very useful for obtaining a more complete understanding of the relationship between total output, marginal and average productivity. First, notice that the total output curve goes through three phases: first, it rises at an accelerating rate; then the rate of its rise slows; finally it reaches its maximum point and begins to decline. Marginal productivity on the graph is the slope of the total output curve. In other words, marginal productivity measures the rate of change
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Figure 24-2. Law of Diminishing Returns
As more and more of a variable resource (labor) is added to a constant quantity of a constant resource (land or capital), the resulting output will first increase at a decreasing rate, then reach its maximum and begin to decrease, as shown in figure a). Marginal productivity in figure b) shows the magnitude of the change in total output associated with the addition of each additional unit of labor. Average productivity is simply the amount of output produced per worker. Note that the marginal productivity curve intersects the average productivity curve at the point maximum value the last one.
decrease in the total output associated with each joining worker. Therefore, the three phases through which total production passes are also reflected in the dynamics of marginal productivity. If total output increases at an increasing rate, marginal productivity inevitably increases. At this stage, additional workers contribute more and more to total production. Further, if the volume of production increases, but at a decreasing rate, the marginal production
driving ability has positive value, but falls. Each additional worker contributes less to total production than his predecessor. When total output reaches its maximum point, marginal productivity is zero. And when total output begins to decline, marginal productivity becomes negative.
The dynamics of average productivity also reflects the “arc-shaped” relationship between
variable inputs of labor and volume of production, which is characteristic of marginal productivity. However, one thing should be noted regarding the relationship between marginal and average productivity: where marginal productivity exceeds average productivity, the latter increases. And wherever marginal productivity is less than average productivity, average productivity decreases. It follows that the marginal productivity curve intersects the average productivity curve precisely at the point at which the latter reaches its maximum. This relationship is mathematically inevitable. If we add to a sum a number greater than the average of its constituent values, then this average must increase. And if the number added to the sum of quantities is less than them average size, then this average necessarily falls. Average level of a number of values grows only if the gain from the use of an additional (marginal) unit of resource is greater than the average of all previous gains. If the added value turns out to be less than the “current” average, then the average will be pulled down as a result. In our example, average productivity will increase as long as the value of the product added by the additional workers to total output exceeds the value of the "average product", or the average productivity of the previously employed workers. Conversely, an additional worker will contribute to a decrease in the "average product", or productivity, if the value he adds to the total volume of production is less than the value of the "average product".
The law of diminishing returns is reflected in the shape of all three curves. However, as follows from the above formulation of the law, economists are primarily interested in marginal productivity. Accordingly, we distinguish between the stages of growth, decline and negative value maximum performance (see Figure 24-2). Looking again at columns 1 and 3 in Table 24-1, we notice the increasing returns associated with employing the first two workers in production, the diminishing returns associated with using the labor of the third, fourth, and so on until the eighth worker, and the “negative return” (absolute decrease in production volume), starting from the ninth worker.
MARGINAL COST
Now we have to consider another very important concept of production costs - the concept of marginal cost. Marginal cost (MC) are called additional, or incremental, costs associated with the production of one more unit of output. MC can be determined for each additional unit of production by simply noticing that change the amount of costs that resulted from the production of that unit.
Since in our example "change in Q" is always equal to one, which is why we defined MC as the cost of production one unit products.
Table 24-2 shows that producing the first unit of output increases total costs from $100 to $190. Therefore, the incremental, or marginal, cost of producing this first unit is $90. The marginal cost of producing the second unit is $80. ($270 - $190); The MC for production of the third unit is $70. ($340 - $270), etc. The MS of production of each of the 10 units of production is presented in column 8 of Table 24-2. MC can also be calculated based on the indicators of the sum of variable costs (column 3). Why? Because the whole difference between the sum of the total
Figure 24-5. Dependence of marginal costs on average total and average variable costs
The marginal cost curve MC intersects the ATC and AVC curves at the points of the minimum value of each of them, this is explained by the fact that while the additional, or marginal, value added to the sum of total (or variable) costs remains less than the average value of these costs, the indicator of average costs are necessarily reduced. Conversely, when the marginal value added to the sum of total (or variable) costs is greater than the average total (or variable) costs, average costs must increase.
and the sum of variable costs represents a fixed amount of fixed costs ($100). Hence, change the total cost is always equal to change the amount of variable costs for each additional unit of production.
The concept of marginal cost is of strategic importance because it identifies those costs over which a firm can most directly control. More precisely, MC shows the costs that the firm will have to incur in the event of producing the last unit of output, and at the same time - the costs that can be “saved” if the volume of production is reduced by this last unit. Average cost indicators Not give such information. For example, imagine that the management of a firm is undecided as to whether the firm should produce 3 or 4 units of output. Table 24-2 shows that the production of 4 units of ATS equals $100, but this does not mean that the firm will increase its costs by $100. in the case of production or, conversely, will “save” 100 dollars by refusing to produce the fourth unit. In fact, the change in costs associated with this production will be only $60, as can be clearly seen from the data given in the MC column of Table 24-2. Making decisions regarding the volume of production usually has a limiting nature, then
There is a decision being made about whether the firm should produce several units more or several units less. Marginal cost reflects the change in costs that would result in an increase or decrease in output by one unit. Comparing marginal cost with marginal revenue, which, as you will learn in Chapter 25, is the change in revenue associated with increasing or decreasing output by one unit, allows a firm to determine the profitability of a particular change in scale of production. The determination of limit values is the central topic of the next four chapters.
Figure 24-5 shows the marginal cost graph. Notice that the marginal cost curve slopes down steeply, reaches its minimum, and then rises quite steeply. This reflects the fact that variable costs, and therefore total costs, first grow at a decreasing and then increasing rate (see Figure 24-3 and columns 3 and 4 in Table 24-2).
MC is the ultimate performance. The shape of the marginal cost curve is a reflection and consequence of the law of diminishing returns. The relationship between the magnitude of marginal productivity and the magnitude of marginal cost is easy to grasp by looking back at Table 24-1. If we assume that each subsequent unit of a variable resource (labor) is purchased at the same price, then the marginal cost of producing each additional unit of output will be fall, as long as the marginal productivity of each additional worker is increase. This is because marginal cost is simply the (fixed) price or cost of paying an additional worker divided by his or her marginal productivity. For example, analyzing the data in Table 24-1, assume that each worker can be hired for $10. Since the first worker's marginal productivity is 10, and paying that worker increases the firm's costs by $10, the marginal cost of producing each of these 10 additional units of output will be $1. (10 dollars : 10). Hiring a second worker will also increase the firm's costs by $10, but the marginal productivity will be 15, so the marginal cost of each of these 15 additional units of output will be $0.67. (10 dollars : 15). In general, as long as marginal productivity rises, marginal cost will fall. However, from the moment the law of diminishing returns takes effect (in this case, starting with the third worker), marginal costs will begin to increase. So, in the case of three workers, the marginal cost will be equal to $0.83. ($10 : 12); with four workers - 1 dollar; with five - 1.25 dollars. etc. The relationship between marginal productivity and marginal costs is obvious: at a given price level (product-
rzhek) for variable resources, increasing returns (that is, an increase in marginal productivity) will be expressed in a fall in marginal costs, and diminishing returns (that is, a decrease in marginal productivity)- in the growth of marginal costs. The MC curve is a mirror image of the marginal productivity curve MC. Take another look at Figure 24-6. As marginal productivity increases, marginal cost necessarily falls. When marginal productivity is at its maximum, marginal cost is at its minimum. The fall in marginal productivity is accompanied by an increase in marginal costs.
Dependence of MS on AVC and PBX. It should also be noted that the marginal cost curve intersects the AVC and ATC curves precisely at their minimum points. It was already said above that such a relationship between limiting and average values is mathematically inevitable, and one example from Everyday life can make this pattern quite obvious. Suppose that in a baseball game, a pitcher allowed his opponents to score an average of three runs per game in the first three games in which he pitched. Then whether his average will decrease or increase as a result of pitching in the fourth (limit) game will depend on whether the additional runs he allows in another game will be less or more than the "current" average of three runs. If he allows fewer than 3 runs - such as one - in the fourth game, his total will increase from 9 to 10 and his average will drop from 3 to 2 1/2 (10:4). Conversely, if he allows more than 3 runs - say 7 - in the fourth game, then his total will increase from 9 to 16, and his average will increase from 3 to 4 (16:4).
The same thing happens with costs. If the amount added to the total cost (marginal cost) is less than average total cost, average total cost will decrease. Conversely, if marginal cost exceeds ATC, then ATC will increase. This means that in Figure 24-5, ATC will fall as long as the MC curve is below the ATC curve, but ATC will rise where the MC curve is above the ATC curve. Therefore, at the intersection point where MC equals ATC, ATC has just stopped falling, but has not yet begun to rise. This, by definition, is the minimum point of the ATC curve. The marginal cost curve intersects the average total cost curve at its minimum point. Since MC can be thought of as an incremental cost to either the sum of total or the sum of variable costs, the same reasoning can be used to explain why the MC curve intersects the AVC curve at the minimum point. However, no such relationship exists between the MC curve and the AFC curve because the two curves are not related to each other; pre-
Figure 24-6. Relationship between productivity and cost curves
The marginal cost (MC) and average variable cost (AVC) curves are the mirror image of the marginal productivity (MP) and average productivity (AP) curves, respectively. Assuming that labor is the only element of variable cost and the price of labor (wage rate) remains constant, marginal cost (MC) can be calculated by dividing the wage rate by marginal productivity (MP). Therefore, when MR rises, MC must fall; when MR reaches a maximum, MS are minimal; and when MR decreases, MS increases. A similar relationship exists between AR and AVC.
unit costs reflect only those changes in costs that are caused by fluctuations in production volume, while fixed costs, by definition, are independent of production volume.
SHIFTING COST CURVES
Changes in either resource prices or production technology lead to shifts in cost curves. For example, if fixed costs were higher than assumed in Table 24-2, they would be equal to, say, $200. instead of $100, the AFC curve in Figure 24-5 would shift upward. The ATC curve would also be higher on the graph because AFCs are
integral part ATS. Note that the location of the AVC and MC curves would remain the same, since it depends on the prices of variable rather than fixed inputs. Therefore, if the price of labor (wages) or other variable resources increased, the AVC, ATC and MC curves would shift upward, while the AFC curve would remain in the same place. A fall in the prices of fixed or variable inputs would cause the cost curves to shift in the opposite direction as described.
If a more efficient production technology were discovered, the efficiency of using all resources would increase. As a result, all the cost indicators presented in Table 24-1 would decrease. For example, if labor is the only variable resource, wages are $10/hour, and average productivity is 10 units of output, then AVC will be $1. But if, due to improvements in production technology, average labor productivity increases to 20 units, then AVC will decrease to 0.5 dollars. Generally speaking, an upward shift in the productivity curves shown at the top of Figure 24-6 will mean a downward shift in the cost curves shown in the bottom of the figure.
Now let's look at the relationship between total production and unit production costs if all inputs are variable.
SUMMARY
1. Economic costs include all payments due to the owners of resources and sufficient to guarantee a stable supply of these resources for a particular production process. They mean external costs paid in favor of suppliers who are independent in relation to the dacha enterprise, as well as internal costs interpreted as compensation for independent use enterprise of its own resources. One of the elements of internal costs is the normal profit of the entrepreneur as a reward for the functions he performs.
2. Within the short run, the firm's production capacity is fixed. A company can use its capacity more or less intensively, increasing or decreasing the amount of consumed
variable resources, but the time available to her is not enough to change the size of her enterprise.
3. The law of diminishing returns describes the dynamics of production volume associated with the increasingly intensive use of fixed production capacity. According to this law, the sequential addition of additional units of a variable resource, for example labor, to a fixed amount of equipment, starting from a certain point, will lead to a decrease in the marginal product obtained as a result of attracting each additional worker.
4. Since production resources are divided into fixed and variable, costs within a short period of time are also either constant or variable. Fixed costs are costs whose value does not depend on the volume of production. Variable costs are costs that vary depending on the volume of production. The total cost of production of a product is the sum of the fixed and variable costs of its production.
5. Average fixed, average variable and average total costs are simply the fixed, variable and total costs of production per unit of output. The value of average fixed costs continuously decreases as production volume increases, since fixed amount costs are distributed over more and more units of output. The average variable cost curve has an arc shape in accordance with the law of diminishing returns. Average total costs are obtained by summing average fixed and average variable costs; The ATC curve also has an arcuate shape.
6. Marginal costs are the additional, or additional, costs of producing one more unit of output. On the graph, the marginal cost curve intersects the ATC and AVC curves at their minimum points.
7. Declining prices for resources, as well as progress in production technology, lead to a shift in cost curves downward. On the contrary, an increase in prices for resources consumed in the production process moves the cost curves upward.
8. A long-term (long-term) period is a period of time long enough for the company to have time to change the quantities of all resources used, including the size of the enterprise. Therefore, in the long run, all resources are variable. The long-term ATC curve, or planning curve, consists of portions of the short-term ATC curves corresponding to the different sizes of plants that a firm can build over a long period of time.
9. The long-term ATC curve usually has an arcuate shape. At the beginning of the process of expansion of production by a small firm, positive economies of scale operate. Whole line factors, in particular more high level specialization of labor and management, the ability to use more productive equipment, and greater recycling of waste through the production of by-products all contribute to economies of scale. Diseconomies of scale arise from the difficulty of managing large-scale production. The relative importance of positive and negative scale effects often has a decisive impact on the structure of the industry.
TERMS AND CONCEPTS
Economic (opportunity) costs
Law of Diminishing Returns
Fixed costs
Variable costs
Average fixed costs
Average variable costs
Average total costs
Marginal cost
Natural monopoly
QUESTIONS AND STUDY ACTIVITIES
1. Show with examples the difference between external and internal costs. What are the external and internal costs of studying at the institute? Why do economists consider normal profit to be a cost element? Is economic profit a cost?
2. Someone Gomez owns small company on production ceramic products. He hires one assistant for 12 thousand dollars. per year, pays 5 thousand dollars. annual rent for production room, and even the raw materials cost him 20 thousand dollars. in year. Gomez invested $40 thousand in production equipment. own funds, which could have brought him 4 thousand dollars in a different location. annual income. Gomez's competitor offered him workplace potter with payment of 15 thousand dollars. in year. Gomez estimates his entrepreneurial talent at $3 thousand. per annum. The total annual income from the sale of ceramics is 72 thousand dollars. Calculate the accounting and economic profit of Gomez's company.
3. Which of the following changes in the composition of productive resources are short-term and which are long-term? a) Texaco is building a new oil refinery; b) Acme-Steel Corporation hires another 200 workers; c) the farmer increases the amount of fertilizers used on his plot; d) a third work shift is being introduced at the Alcoa factory.
4. Why in the short term can all costs be divided into fixed and variable? Determine which category of costs the following types of costs belong to: costs of advertising products; for the purchase of fuel; payment of interest on loans issued by the company; sea transportation fees; raw material costs; payment of property taxes; salaries for management personnel; insurance premiums; workers' wages; depreciation deductions; sales tax; payment for office equipment rented by the company. "In the long run, there are no fixed costs; all costs are variable." Explain this statement.
5. List the fixed and variable costs associated with operating your own car. Suppose you are wondering how best to travel the thousand miles to Fort Lauderdal during spring break: by your car or by plane? What costs—fixed, variable, or both—will you have to consider when deciding this issue? Will you incur any internal costs? Explain.