production cost revenue n.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Production Cost & Revenue PowerPoint Presentation
Download Presentation
Production Cost & Revenue

Loading in 2 Seconds...

play fullscreen
1 / 59

Production Cost & Revenue - PowerPoint PPT Presentation


  • 211 Views
  • Uploaded on

Production, Costs and Revenue. Production Cost & Revenue. To give basic idea about production function. To give basic idea about various costs and revenue concepts. To show the behavior and shapes of short and long run costs and revenue concepts and the reasons behind that.

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Production Cost & Revenue' - avon


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
production cost revenue

Production, Costs and Revenue

Production Cost & Revenue

To give basic idea about production function.

To give basic idea about various costs and revenue concepts.

To show the behavior and shapes of short and long run costs and revenue concepts and the reasons behind that.

To give basic idea about economies of scales and scope concepts.

To give basic idea about profits maximization.

Application of these concepts to practice.

slide2

Production, Costs and Revenue

  • Production, costs and revenues are related with the supplytheory.
  • Can we analyze various business organizations through one theory or do we need many theories. One general framework with adjustment to suit with various market structures.
  • Before deciding the output level, firm has to know two important issues: How much will it cost to produce and how much revenue will it generate

Price

Cost of production

Firm chooses

Level of output and fixed the price

Revenue

Output

slide3

The complete theory of supply

Demand curve facing the firm (prices at which the firm can sell each level of output)

Total cost curves, short-run and long run

Technology and costs of hiring factors of production

Marginal cost curves, short-run and long run

Firm chooses level of output

Marginal revenue curve

Checks: Whether to produce at all in short-run: whether to close down in long run

Average cost curves, short-run and long run

Modeling

slide4

Production

The term production refers to more than the physical transformation of resources. Production involves all the activities associated with providing goods and services. Thus the hiring of workers (from unskilled labor to top management), personnel training, and the organizational structure used to maximize productivity are all part of the production process.

Input: any good or service used to produce output.

A technique: a particular method of combining inputs to make outputs.

Technology: is the list of all known techniques

Technical progress: production of a given output with less inputs than before or shift in production possibility curve.

slide5

The Production Function

-A production function is a descriptive statement that relates inputs to outputs.

- A technical relationship between physical inputs and outputs.

- It specifies the maximum possible output that can be produced for a given amount of inputs.

- The minimum quantity of inputs necessary to produce a given level of output.

- Production functions are determined by the technology availability to the firm.

the production function

Inputs

Outputs

FOPs

The Production Function
  • Inputs - FOPs (Factors of production)

(labour, land, materials, capital,

knowledge, etc)

Firm

“Black Box”

the functional form
The Functional Form

Q = f (costs, ...)

This can be separated into :

  • Q = f (K, L, La, M, ...)

Q = output, K = capital, L = labour, La = land,

M = materials

Or in its most usual form :

  • Q = f (K, L)
slide8

Technical efficiency and economic efficiency in production

Technical efficiency is a method of production which involves the minimum amount of a combination of different factors .

Economic efficiency is the use of resources to produce any given output level at minimum cost.

See page no. in your second text book

slide9

Time Duration in Economics

The Short Run (Time period when at least one factor is in fixed supply. Output can be changed by using variable factor with the fixed factor. The length of the short run change firms to firms and industry to industry.)

Q = f (K - fixed factor, L - variable factor)

The Long Run (No fixed factors or all the factors are variable except technology.)

The Very Long Run (The time period over which technology might change.)

Economists analyze production, costs and revenue with respect to these short and long run periods.

fixed and variable factors
Fixed and Variable Factors
  • in the short run (SR), at least one of the factors is fixed in supply (“the operating period”)
  • can split SR costs into “fixed” and “variable”
  • fixed costs are costs which do not vary in the short-run with the level of output
    • (e.g. rent, interest payments, capital depreciation..)
  • variable costs are costs which do vary in the short run with the level of output
    • (e.g. raw materials, heating and lighting, waged labour...)
slide11

In studying production functions, there are two types of relations between inputs and outputs that are of interest for managerial decision making.

1. Returns to scale

Relation between output and the variation in all inputs taken together.

This plays an important role in managerial decisions.

They affect the optimal scale, or size of a firm and its production facilities.

They also affect the nature of competition in an industry and thus are important in determining the profitability of investment in a particular economic sector.

slide12

2. Returns to a factor

The relation between output and variation in only one of the inputs employed.

The terms factor productivity and returns to a factor are used to denote this relation between the quantity of an individual input (or factor of production) employed and the output produced.

Factor productivity provides the basis for efficient resource employment in a production system.

slide13

TOTAL, AVERAGE, AND MARGINAL PRODUCT

Total Product (TP): The total output that results from employing a specific quantity of resources in a production system.Generally this TP will rise as more units of labor are employed with fixed volume of capital.But the trend of this curve has different rates of increases:first it increases at an increasing rate,then at a decreasing rateand finally it will decline. The explanation for this behavior can be explained through the concept of marginal product.

Marginal Product (MP): The change in output associated with a unit change in one input factor, holding other inputs constant.

MP = d(TP)/dQ or ATP/AQ

This curve first goes up due to workers specialization and spare capacity in fixed factor and then goes down due to full utilization of the fixed factor.

slide14

Average Product (AP)

Total product divided by the units of inputs employed.

AP = TP/L

This curve first goes up then goes down

Relationship between AP and MP: AP goes up then MP above it and AP goes down then MP below it. This relationship can be explained through principle of diminishing returns.

Principle of Diminishing Returns: More units of a variable factor (L) are combined with a given number of fixed factors (K) there comes a point where the returns to the variable factor begin to decline.

slide18

APx

MPx

Average and Marginal Products

slide19

The Law of diminishing returns

As thequantity of a variable input increases, with the quantities of all other factors being held constant, the resulting increases in output eventually decrease.

Holding all factors constant except one, the law of diminishing returns says that, beyond some level of the variable input, further increases in the variable input lead to a steadily decreasing marginal product of that output.

slide20

Cost Analysis

Cost Analysis plays a central role in managerial economics because virtually every managerial decision requires a comparison between costs and benefits.

There are number of other cost concepts.

Relevant cost and Opportunity cost

Accounting cost and economic cost

Explicit vs implicit costs

Marginal cost or Incremental Cost

Sunk cost (while leaving industry you can not recover this costs) and fixed cost

Short and long-run costs

slide21

Short-run Costs

Short-run Total Costs

Total Cost: TC (fixed and variable costs in production)

Total Fixed Cost: TFC (Cost which does not change with output and it is the overhead or capital costs. The curve is a horizontal or flatter)

Total Variable Cost: TVC (Cost which change with output: labor and raw materials). This curve is the inverse shape of TP curve.First it increases at decreasing rate (additional unit of labour add more value to production) and then increases at increasing rate (additional unit of labour add more to cost rather to production).

TC = TFC + TVC, TFC = TC - TVC, TVC = TC - TFC

slide22

Short-run Average Total Costs

TC/Q = TFC/Q + TVC/Q

ATC = AFC + AVC

AFC (falls as output increases and it is continually down-ward slopping. It is the fixed costs per unit of output produced).

AVC (first falls and then rise and it is the inverse shape of AP curve: AP rises then AVC falls AP falls then AVC rises due to changes in labor productivity.

ATC (first falls and then rise mainly due to AVC curve)

AFC = ATC - AVC, AVC = ATC - AFC

slide23

Marginal Cost is the increase in total cost when output is increased by 1 unit:

MC = d(TC)/dQ

Its behaviour starts at high then falls then again rises.

The main reasons for this behaviour is production techniques

(at low level of output – simple techniques then costs go up

Output increases – sophisticated techniques then economies of scales. Output further increases – diseconomies of scales such as Organizational problems – cost go up).

Generally MC, AVC and ATC show some relationship.

If MC < AVC then AVC falls

If MC = AVC then AVC is at minimum

If MC > AVC then AVC rises

Same relationship holds between MC and ATC

slide25

Short Run Cost Curves

$ per time period

Increasing productivity of variable factors

Decreasing productivity of variable factors

Fixed cost = OF

Total cost

Variablecost

F

Total Variable cost

Fixed cost

O

Q2

Q3

Q1

Output per time period (units)

Total Costs

slide26

Short Run Cost Curves

MC

ATC

AVC

AFC

O

Q2

Q3

Q1

Cost

Output

Profit maximising output Q1

MR

bringing fc and vc together

ATC

AVC

TFC

AFC

q1

Bringing FC and VC together

Cost (£)

0

Quantity (no. of units)

atc and mc

MC

ATC

q*

ATC and MC

Cost (£)

0

Quantity (no. of units)

slide29

The Relationship between Average and Marginal Curves

  • AC is falling when MC is less than AC, and rising when MC is greater than AC (AC is declining whenever MC is below AC, and rising whenever MC above).
  • AC is at minimum at the output level at which AC and MC cross (MC cuts the minimum point of AC).
slide30

Short-run Optimality

Full or optimum capacity = firm produces at minimum level of short-run average cost curve and at this point all the inputs are employed to their optimum efficiency.

If the firm faces long U shape (Saucer) cost curve, the range of the minimum points are called load factor or normal capacity utilization.

If firm producing a point right to this then it’s average costs is rising.

If firm is producing left to this point then firm has a reserve capacity; firm is not fully utilizing its factors of production.

slide31
Self-study Exercise 1: Identify the main fixed and variable costs need to operate within the following industries...
  • Newspaper business
  • Jewellery retailing
  • Electronic components manufacture
  • Electricity generation
  • Software development
  • Cellular telecommunications
  • Hotel management
slide32

Long-Run Cost Curves

In the long run all the factors are variable and accordingly firm can change it’s scale of the operation. However firms can not change all the variables together. Therefore, long-run is going to be a series of short run periods.

During this period firms will change the scale of production (the amount firm is able to produce in relation to its size) which will affect for productive efficiency in three ways:

1) Constant returns to scale

2) Increasing returns to scale

3) Decreasing returns to scale

lr average costs
LR Average Costs
  • in the long run, quantities of all inputs can be varied (“the planning horizon”)
  • this means that there are no fixed costs in the long run
  • and so the LRAC curve is different from the SRAC we’ve considered so far…. It is more enlarge U (saucer) shaped one. It is the envelope of the short-run cost curves.
the long run average cost curve

LRAC

SRAC1

c1

SRAC5

SRAC4

SRAC2

c2

SRAC3

c*

q1

q2

q4

q5

q*

The Long Run Average Cost Curve

LRMC

cost (£)

0

The relationships between LRAC and LRMC same like in short-run.

units of output

economies and diseconomies of scale
Economies and diseconomies of scale

There are economies of scale (increasing returns to scale) when long-run average cost decreases as output rises or volume of output rises more quickly than the volume of inputs.

There are constant returns to scale when long-run average cost are constant as output rises or volume of output increases in the same proportion to the volume of inputs .

There are diseconomies of scale (decreasing returns to scale) When long-run average cost increase as output rises or volume of output rise less quickly than the volume of inputs.

These are explained by the presence of both internal and external economies and diseconomies of scale in production.

returns to scale

Increasing returns to scale

Constant returns to scale

LRMC

LRAC

LRAC

LRMC

q1

q2

Minimum efficient scale (MES)

Returns to Scale

Decreasing returns to scale

Cost (£)

0

Quantity (no. of units)

slide37

The long- run average cost curve

Average (i.e. per unit) cost of production

Increasing returns to scale

Decreasing returns to scale

Constant returns to scale

Decreasing cost production

Increasing cost production

Constant cost production

O

q1

q2

Output expansion over the long run

increasing returns to scale
Increasing returns to scale
  • Read the given handout part
  • Internal economies of scale – economies internal to the firm resulting from a more efficient utilization of resources. This can be technical or non-technical: labour, investment indivisibilities, large scale procurement, R &D,capital, diversification, promotion, transport and distribution, by-products, specialization, flexible manufacturing large scale necessary to take advantage, reserve capacity, end of learning period.
  • External economies of scale – economies brought about by the growth or conentration of the industry: existence of goodlabour force, existence of network of suppliers, existence of social economic and environmental infrastructure.
slide39

Decreasing returns to scale

(Internal diseconomies of scale - management, labour, other inputs, External diseconomies of scale – geography of concentration, range of business, time of the business).

Solution to the decreasing returns to scale

1) Relocation of operation

2) Contracting-out

3) Reorganization of management structures

4) Lay-off the workers

5) Productivity increase by new technology and HR programmes.

slide40

Minimum Efficient Scale (MES)

The point at which the long run average cost curve first becomes horizontal (flatter) and it is the technical optimum scale of production. It gives a firm a strong competitive advantage in the market place over higher cost producers.

Beyond this MES, firms do not have additional economies of scales.

Expanding scale firms can further enjoy MES status. Then managerial problems and other diseconomies are going to emerge.

slide41

Economies of Scope

This exist where several different outputs draw on a common

resources and it is a diversification in a same or different

production and marketing lines. This diversification leads to

cost savings. Generally economies of scale and scope reinforce each other to minimize cost.

The Degree of Economies of Scope (DES)

DES = {[TC(An) + TC(Bn)] –TC (An + Bn)}/[TC (An+Bn)]

TC(An) = Total cost of producing An units of product A separately

TC(Bn) = Total cost of producing Bn units of product B separately

TC (An+Bn) = Total cost of producing A and B jointly

DES < 0 Negative ES. It is better to produce separately

DES >0 Positive ES. More economical to produce jointly.

Generally economies of scale and economies of scope are reinforcing each other to reduce costs.

sources of economies of scale and scope

Pecuniary Economies

Real Economies

Selling/

Marketing

Managerial

Production

Other

Bulk buy raw materials

Lower cost of finance

Lower cost of advertising

Lower transport rates

Lower R & D costs

Labour

Capital

Inventory

Specialisation/team-working

Decentralisation

Mechanisation

Advertising

Large-scale promotion

Exclusive dealers

Transport

Storage

R & D efficiencies

By-product production

Experience curves

Sources of Economies of Scale and Scope

Economies of Scale

source : adapted from Koutsoyiannis (1979)

slide43

X-inefficiency

The situation of wastage of firm’s resources and its costs higher than necessary level. This can happen due to managerial or technological or any other factor. This firm can not exist market in long-run. Most of the public sector institutions have this problem. But generally in the long-run in competitive markets, firms can not survive if they have X-inefficiency problem: full efficient firms only survive. We can measure it as actual cost point - MES = (q1a-q1b) =ab

C

LRAC

a

b

q

q1

0

slide44

The Learning Effect (Accumulative productive experience)

  • Firm accumulate its business experience over the years which improve its production and organizational methods which ultimately reduces the cost of production. -learning by doing approach-
  • At managerial level the learning effects occurs
  • Perfection and precision reached due to constant practice of managerial decision making.
  • Finding more efficient production and business procedure.
  • Knowing better ways to use tools and equipments.
  • Familiarization with the production activities which helps to give good instructions to subordinates.
  • Right placement of right people.
  • Better co-ordination and control.
  • Good integration of works.
  • Better TQM
  • Better project management and scheduling

Cost per unit

LRAC

Cumulative output

slide45

Learning Effect Rate (LER)

LER = [ 1- (ACt1/ACt0)] *100

ACt1 = Average cost in initial period (t0) increment

ACt0 = Average cost in next period (t1) increment

ACt1/ACt0 = Experience factor

This measures percentage decrease in additional cost with respect to a 100 per cent increase in output at each time.

For working examples see Mithani.D.M (2000),

Managerial Economics, Theory and Applications,

Himalaya Publishing House, Page 280-1

slide46

Self-study Exercise 2: What are the potential sources of economies of scale and scope in the following industries/Or in your firm/organization?

1) Consumer finance

2) Pharmaceuticals

3) Printing

4) Road construction

5) Recorded music industry

6) Shoe manufacture & retail

7) Training and education provision

slide47

Profits Maximization

Total Revenue - Total Costs = Profits

TR - TC = Profits

d(TR)/dQ - d(TC)/dQ = Marginal profits

MR = MC, Profits maximizing condition or rule

Marginal revenue = Marginal cost

Profits maximising output decision:

MR > MC Q should goes up

MR = MC Q profit maximising output

MR < MC Q should goes down

Profits maximising output and revenue maximising output are two different concepts (see next table).

slide49

Marginal Cost is the increase in total cost when output is increased by 1 unit:

MC = d(TC)/dQ

Its behaviour starts at high then falls then again rises.

MC

MC

0

Q

slide50

Marginal revenueis the increase in total revenue when output is increased by 1 unit. Its behaviour depends on the firm’s demand curve . Generally it is a downward for most market structures except perfect competition (horizontal).

Perfect Competition

P

Other Markets

P

MR/D/P

0

0

Q

Q

AR =D

MR

slide51

Profits Maximization in Short Run

MC

ATC

AVC

AFC

O

Q2

Q3

Q1

MR > MC

MC < MR

Profits maximising output Q1

MR

slide52

Comparative Static Analysis

MC MR

MC 1

MC

MC 2

MR

Q

0

Q1

Q

Q2

slide53

Comparative Static Analysis

MC MR

MC

MR2

MR

MR1

Q

0

Q1

Q

Q2

slide54

See figure a (TR, TC and profits curves)

1) Break even points Q1 and Q4 (TR = TC).

2) Loss making area below Q1 and above Q4 (TC>TR).

3) Profits making area between Q1 - Q4 (TR>TC).

4) Maximum profits in Q2 (highest difference between TC and TR).

See figure b (MC, AC, AR and MR curves)

These two figures are interrelated:

1) Break even points Q1 and Q4 (AC=AR).

2) In loss making area below Q1 and above Q4 (AC > AR).

3) Profits making area between Q1 and Q4 (AR > AC).

4) Maximum profits in Q2 (MR =MC, Moving to right from Q1 MR>MC. Moving to left from Q4 MR>MC, Moving right to Q2 MR<MC. Therefore the best point is Q2).

slide55

Figure a

Figure b

slide57

Normal Profits

At a breakeven point firm makes zero profits. But economists name it as a normal profits based on the opportunity cost concept.

Abnormal Profits (Super normal profits)

Surplus above the normal profits. Between Q1 and Q4

Shut-Down Price

Below the normal profits firm does not get full cost recovery. Therefore, they will decide to shut-down the business.

slide58

The Shut-down Position in Short-run

Price and Cost

SRAC

SRMC

SRAVC

Abnormal profits

D5 = MR5

P5

D4 = MR4

Normal profits

P4

D3 = MR3

P3

Shut-down price

D2 =MR2

P2

P1

D1 =MR1

Q3

Q2

0

Q4

Q1

Q5

Output

slide59

Exercise

Usage of profits maximizing model to loss making firm - Baldwin’s fashion Ltd

This firm make profits till very recent but now in loss and considering closing down. Your advice to regain the profits and to remain in the industry.

Solutions:

1)Decreasing variable costs

2) Decreasing fixed costs

3) Increasing the level of demand

4) Combinations of all these