CONCEPT OF PRODUCTION

Production
Transformation of inputs into outputs. Creation of any good or service for the purpose of selling to buyers. By business firms, by government agencies, and by non-profit institutions.
Inputs of production-factors of production (land, labor, capital and entrepreneur)
FIXED OR VARIABLE FACTORS

Outputs of production-result that has been created by the inputs

Examples:
Farmer producing vegetables Psychiatrist producing specialized service Songwriter producing new song DPWH producing roads Suzuki producing motorcycles THUS: production, generally , is any activity that creates value

EDUCATION AS PRODUCTION ACTIVITY

-teachers, administrator, buildings, equipment

INPUTS

PRODUCTION ACTIVITY

-(the means of transforming inputs into outputs) -like actual classroom activities

-educated students
OUTPUTS

Production Functions
Relationship between the amount of inputs required and the amount of output that can be obtained
Various combination of inputs will result to different quantities and qualities of output. 100 cavans of palay-use of farming technology on a given hectare of land, use of a certain quantity and quality of seeds and given number of bags of pertilizer.

Production Functions
A schedule (table or mathematical equation) showing the maximum amount of outputs that can be produce from any specified set of inputs given the existing technology A catalog of output possibilities

PRODUCTION FUNCTION
The production function shows the relationship between quantity of inputs used to make a good and the quantity of output of that good.

Analysis of Production Process

1. Classes of inputs
Two types: Fixed =one whose quantity cannot be readily changed when market conditions indicate that a change is output if desirable (building, equipment) Variable= can be readily changed when a change in output is desired. (raw materials, labor, supplies)

2. Time Frame References

Consist of short run and long run
Short-run=time frame in which input of one or more productive agents is fixed. Long-run=period of time in which all inputs are variable
Time factor is dependent across firms and industries

Production with one Variable Input

As number of inputs in any production process varies from one to about a hundred, it is difficult to make a detailed analysis of all variations thus, simplify by making assumptions
There is only one variable input which can be combined in different proportions with fixed inputs to produce various quantities of output

Total, Average and Marginal Products

Total output/total product (TP)
Refers to the total amount of output produced in physical units (bags, bottles, pairs)

Average product (AP)

Total output divided by the quantity of the variable inputs under consideration

Marginal Product (MP)

Additional output attributed to the increase in the quantity of the variable inputs under consideration.

Marginal Product
The marginal product of any input in the production process is the increase in output that arises from one additional unit of that input.

Note that the marginal product diminishes as more of the resource is used. This is a common assumption in economics.

Diminishing Returns in Production

Diminishing marginal product is the property whereby the marginal product of an input decreases as the quantity of the input increases.
Example: As more and more workers (variable) are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment (fixed) that all workers must share.

Thus:
As more of the same input is employed in the production of a particular good, the corresponding increase in total output tends to become smaller and smaller, if the amount of the other inputs required in the production process are kept constant.

Figure 2 Carolines Production Function

Quantity of Output (cookies per hour) 150 140 130 120 110 100 Production function

90 80
70 60 50 40 30 20 10 0 1 2 3 4 5

Note that this production function graph shows diminishing marginal product.

Number of Workers Hired

PRODUCTION AFFECTS COSTS

Cost of Production
In analysis of cost of production, short run and long run time frames must be considered.
Short run cost=producing the output requires a combination of fixed and variable costs. Long run cost=fixed inputs that cannot be changed in the short run can be increase(decreased) in the long run.

THE VARIOUS MEASURES OF COST

Total Cost=sum total of all the expenditures in producing goods and services.
consists of fixed costs and variable costs.

Fixed costs are those costs that do not vary with the quantity produced. Variable costs are those costs that vary with the quantity produced.
TC = FC + VC

Types of short-run costs:

Total fixed costs (TFC)-costs that do not vary with output Total average costs (TVC)-costs that vary with output Total costs (TC)-sum of total fixed costs and total variable costs TC=TFC+TVC Average fixed costs (AFC)-total fixed costs divided by the umber of output produced (Q)
AFC=TFC/Q

Types of short-run costs:

Average variable costs (AVC)=total variable costs divided by the number of output produced (Q)
AVC=TVC/Q

Average total costs (ATC)=total costs divided by the number of output produced (Q) also known as cost per unit of output.
ATC=ATC/Q

Types of short-run costs:

Marginal costs (MC)=changes in total costs divided by the change in output produced (Q) An additional cost incurred from producing additional unit of output.
MC= TC/Q

Table 1 A Production Function and Total Cost: Carolines Cookie Factory

Fixed Cost Variable Cost

Number of workers

Output (quantity of cookies produced per hour)

Marginal product of labor

Cost of factory

Cost of workers

Total cost of inputs (cost of factory + cost of workers)

0 1 2 3 4 5 6

0 50 90 120 140 150 155

50 40 30 20 10 5

$30 30 30 30 30 30 30

$0 10 20 30 40 50 60

$30 40 50 60 70 80 90

Turning these two columns into a graph yields the cost curve. See next slide.

Figure 2 Carolines production function and total-cost curve

Quantity of Output (cookies per hour) 160 140 120

(a) Production function

Production function

Total Cost $90 80 70 60 50 40 30

(b) Total-cost curve

Total-cost curve

100
80 60 40 20 0 1 2 3 4 5 6 Number of Workers Hired

20
10 0 20 40 60 80 100 120 140 160 Quantity of Output (cookies per hour)
23

The various measures of cost: Conrads Coffee Shop

Quantity of coffee (cups per hour) Total Cost Fixed Cost Variable Cost Average Fixed Cost Average Variable Cost Average Total Cost Marginal Cost

0 1 2 3 4 5 6 7 8 9 10

$3.00 3.30 3.80 4.50 5.40 6.50 7.80 9.30 11.00 12.90 15.00

$3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00

$0.00 0.30 0.80 1.50 2.40 3.50 4.80 6.30 8.00 9.90 12.00

$3.00 1.50 1.00 0.75 0.60 0.50 0.43 0.38 0.33 0.30

$0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 1.10 1.20

$3.30 1.90 1.50 1.35 1.30 1.30 1.33 1.38 1.43 1.50

$0.30 0.50 0.70 0.90 1.10 1.30 1.50 1.70 1.90 2.10

Check that TC = FC + VC

24

Figure 3 Conrads Coffee Shop Total-Cost Curve

Total Cost $15.00 14.00 13.00 12.00 11.00 10.00 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0 1 2 3 4 5 6 7 8 9 10 Total-cost curve

Quantity of coffee (cups per hour)

Total Cost $3.00 3.30 3.80 4.50 5.40 6.50 7.80 9.30 11.00 12.90 15.00

0 1 2 3 4 5 6 7 8 9 10
Quantity of Output (cups of coffee per hour)

Average Costs

Fixed cost FC AFC Quantity Q Variable cost VC AVC Quantity Q Total cost TC ATC Quantity Q

Average Fixed and Variable Costs

We know that TC = FC + VC Therefore, TC/Q = FC/Q + VC/Q Therefore, ATC = AFC + AVC

The various measures of cost: Conrads coffee shop

Quantity of coffee (cups per hour) Total Cost Fixed Cost Variable Cost Average Fixed Cost Average Variable Cost Average Total Cost Marginal Cost

0 1 2 3 4 5 6 7 8 9 10

$3.00 3.30 3.80 4.50 5.40 6.50 7.80 9.30 11.00 12.90 15.00

$3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00

$0.00 0.30 0.80 1.50 2.40 3.50 4.80 6.30 8.00 9.90 12.00

$3.00 1.50 1.00 0.75 0.60 0.50 0.43 0.38 0.33 0.30

$0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 1.10 1.20

$3.30 1.90 1.50 1.35 1.30 1.30 1.33 1.38 1.43 1.50

$0.30 0.50 0.70 0.90 1.10 1.30 1.50 1.70 1.90 2.10

Check that ATC = TC/Q, AFC = FC/Q, and AVC = VC/Q Check that ATC = AFC + AVC
29

Figure 4 Conrads Coffee Shop Average-Cost and Marginal-Cost Curves

Costs $3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75

1. 2. 3.

AFC decreases as Q increases, AVC increases as Q increases, because of diminishing returns. As ATC = AFC + AVC, ATC is Ushaped; as Q increases, it decreases initially and then begins to increase.

1.50
1.25 1.00 0.75 0.50

ATC AVC

0.25
0 1 2 3 4 5 6 7 8 9 10

AFC Quantity of Output (cups of coffee per hour)

Marginal Cost

(change in total cost) TC MC (change in quantity) Q

increase in total variable cost VC MC increase in production Q

The various measures of cost: Conrads coffee shop

Quantity of coffee (cups per hour) Total Cost Fixed Cost Variable Cost Average Fixed Cost Average Variable Cost Average Total Cost Marginal Cost

0 1 2 3 4 5 6 7 8 9 10

$3.00 3.30 3.80 4.50 5.40 6.50 7.80 9.30 11.00 12.90 15.00

$3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00 3.00

$0.00 0.30 0.80 1.50 2.40 3.50 4.80 6.30 8.00 9.90 12.00

$3.00 1.50 1.00 0.75 0.60 0.50 0.43 0.38 0.33 0.30

$0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 1.10 1.20

$3.30 1.90 1.50 1.35 1.30 1.30 1.33 1.38 1.43 1.50

$0.30 0.50 0.70 0.90 1.10 1.30 1.50 1.70 1.90 2.10

Check that MC = TC/ Q = VC / Q

34

Figure 4 Conrads Coffee Shop Average-Cost and Marginal-Cost Curves

Costs $3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 MC

Marginal cost rises with the amount of output produced. This reflects the assumption of diminishing marginal product

1.50
1.25 1.00 0.75 0.50

0.25
0 1 2 3 4 5 6 7 8 9 10 Quantity of Output (cups of coffee per hour)

Figure 4 Conrads Coffee Shop Average-Cost and Marginal-Cost Curves

Costs $3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 MC

1.50
1.25 1.00 0.75 0.50

ATC AVC

0.25
0 1 2 3 4 5 6 7 8 9 10

AFC Quantity of Output (cups of coffee per hour)

Cost Curves and Their Shapes

Relationship Between Marginal Cost and Average Total Cost
Whenever marginal cost is less than average total cost, average total cost must be decreasing. Whenever marginal cost is greater than average total cost, average total cost must be increasing.

Cost Curves and Their Shapes

Relationship Between Marginal Cost and Average Total Cost
The marginal-cost curve crosses the average-totalcost curve at the efficient scale.
Efficient scale is the quantity that minimizes average total cost.

Figure 4 Conrads Coffee Shop Average-Cost and Marginal-Cost Curves

Costs $3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 MC

1.50
1.25 1.00 0.75 0.50

ATC

0.25
0 1 2 3 4 5 6 7 8 9 10 Quantity of Output (cups of coffee per hour)

Typical Cost Curves

Three Important Properties of Cost Curves
Marginal cost eventually rises with the quantity of output. The average-total-cost curve is U-shaped. The marginal-cost curve crosses the average-totalcost curve at the minimum of average total cost.

COSTS IN THE SHORT RUN AND IN THE LONG RUN

For many firms, the division of total costs between fixed and variable costs depends on the time horizon being considered.
In the short run, some costs are fixed. In the long run, fixed costs become variable costs.

COSTS IN THE SHORT RUN AND IN THE LONG RUN

Because some costs are fixed in the short run and variable in the long run, a firms long-run cost curves differ from its short-run cost curves.

Figure 6 Average Total Cost in the Short and Long Run

Average Total Cost

ATC in short run with small factory

ATC in short ATC in short run with run with medium factory large factory

$12,000

ATC in long run

1,200

Quantity of Cars per Day

Economies and Diseconomies of Scale

Economies of scale refer to the property whereby long-run average total cost falls as the quantity of output increases. Diseconomies of scale refer to the property whereby long-run average total cost rises as the quantity of output increases. Constant returns to scale refers to the property whereby long-run average total cost stays the same as the quantity of output increases

Figure 6 Average Total Cost in the Short and Long Run

Average Total Cost

ATC in short run with small factory

ATC in short ATC in short run with run with medium factory large factory

ATC in long run

$12,000 10,000 Economies of scale

Constant returns to scale

Diseconomies of scale Quantity of Cars per Day

1,000 1,200

Summary
The goal of firms is to maximize profit, which equals total revenue minus total cost. When analyzing a firms behavior, it is important to include all the opportunity costs of production. Some opportunity costs are explicit while other opportunity costs are implicit.