Production and Costs
profit margin:
at a given level of output, the difference between price and average cost; also known as average profit
production function:
mathematical equation that tells how much output a firm can produce with given amounts of inputs
accounting profit
total revenues minus explicit costs, including depreciation
Suppose that a firm produces 10 units of output. Its Average Variable Cost (AVC) = $25, Average Fixed Cost (AFC) = $5, and Marginal Cost (MC) = $30. The firm's ________.
Total cost is $300
Implicit costs are ________.
a foregone opportunity to do something else with your resources
production technologies:
alternative methods of combining inputs to produce output
firm:
an organization that combines inputs of labor, capital, land, and raw or finished component materials to produce outputs.
A production function describes how firms
combine capital, labor and other inputs to create products.
sunk costs:
fixed costs that, once incurred, cannot be recouped
implicit costs:
opportunity cost of resources already owned by the firm and used in business, for example, expanding a factory onto land already owned
explicit costs:
out-of-pocket costs for a firm, for example, payments for wages and salaries, rent, or materials
long run:
period of time during which all of the firm's inputs are variable
short run:
period of time during which at least one or more of the firm's inputs is fixed
private enterprise:
the ownership of businesses by private individuals
total cost:
the sum of fixed and variable costs of production
Consider a firm with the following production schedule: Assume that each worker gets paid $15 per hour and that other cost of materials is $2 per item produced. Estimate the cost of producing 45 units. It is ________.
$135 3 workers are required to produce 45 units/hour and each gets paid $15 so labor cost if 3*$15=$45. The cost of material is $2 per unit so 45*$2=$90 is the cost of material. Total cost for 45 units = $45+$90-$135.
Consider a firm with the following production cost: When producing 3000 units, what is the marginal cost of producing an additional unit?
$14 The marginal cost of the 4th unit is the change in total cost ($32-$18)=$14
The WipeOut Ski Company manufactures skis for beginners. Fixed costs are $30. Fill in Table for total cost, average variable cost, average total cost, and marginal cost. Complete the chart by filling in the missing numbers: What is the marginal cost in C?
$20
Consider a firm with the following cost of production: If this firm produces 4 units, the average variable cost and average total cost will be:
$21.25 and $31.25 respectively Average variable cost = variable cost / quantity produced = $85/4=$21.25 and average total cost = total cost / quantity produced = $125/4 = $31.25
Consider a firm with the following production schedule: Assume that each worker gets paid $15 per hour and that other cost of materials is $2 per item produced. Estimate the average total cost or cost per unit when producing 45 units. It is ________.
$3 per unit $135 is the total cost for $45 units = $45 +$90-$135. The average cost or cost per unit = $135/45 units = $3 per unit.
Nicole owns a restaurant called Maggio's Italian Bakery. Which of the following best represents the capital used in the production of bread and pastries for Nicole's store?
The oven used to bake the bread and pastries. The oven for a bakery would be considered capital: machines, tools, and other manufactured items use in the production of other goods (bread and pastries)
variable cost:
cost of production that increases with the quantity produced; the cost of the variable inputs
fixed cost:
cost of the fixed inputs; expenditure that a firm must make before production starts and that does not change regardless of the production level
If a solar panel manufacturer wants to look at its total costs of production in the short run, which of the following would provide a useful starting point?
divide total costs into two categories: fixed costs that can't be changed in the short run and variable costs that can be
revenue:
income from selling a firm's product; defined as price times quantity sold
Progress Medical Center acquires a new prescription delivery system where a robot fills up doctor's prescriptions and delivers the medications directly to the hospital's patients; a task previously done by nurses. The new system reduces errors and improves the speed of delivery which allows nurses to focus on patient care. The new production technology
is improving patient care and reducing the cost of care.
leviathan effect:
when a firm gets so large that it operates inefficiently, experiencing diseconomies of scale
If a restaurant is producing and selling 1000 sandwiches per week at an average price of $10. On average, each sandwich cost $4 to make. According to the provided information, the restaurant's profit margin is ________.
$6. Profit margin = price - average cost = $10-$4=$6
Production involves a number of important decisions that define the behavior of firms. These decisions include, but are not limited to:
- What product or products should the firm produce? - How should the products be produced (i.e., what production process should be used)? - How much output should the firm produce? - What price should the firm charge for its products? - How much labor should the firm employ?
Economists divide factors of production into several categories:
- Natural Resources - Labor - Capital - Technology - Entrepreneurship
factors of production (or inputs):
resources that firms use to produce their products, for example, labor and capital
short-run average cost (SRAC) curve:
the average total cost curve in the short term; shows the total of the average fixed costs and the average variable costs
economic profit
total revenues minus total costs (explicit plus implicit costs)
Suppose you own a profitable tailoring company that hires two workers. The combined production of the two workers is ten shirts per day. You decide to double the amount of capital and labor and see that the total number of shirts produced each day has increased to 22. This implies that your company is exhibiting ________.
Economies of scale
average total cost:
for any quantity of output, total cost divided by the quantity of output
average variable cost:
for any quantity of output, variable cost divided by the quantity of output
long-run average cost (LRAC) curve:
shows the lowest possible average cost of production, allowing all the inputs to production to vary so that the firm is choosing its production technology
Factor payments:
what the firm pays for the use of the factors of production-includes raw materials, rent, wages and salaries, interest and dividends, and profit for entrepreneurship.
marginal cost:
the additional cost of producing one more unit; mathematically, MC=ΔTC/ΔQ.
economies of scale:
the long-run average cost of producing output decreases as total output increases
production:
the process of combining inputs to produce outputs, ideally of a value greater than the value of the inputs
A production function describes:
How Yogurt and Co. uses milk, sugar, fruits, packaging materials, labor, machinery and building to produce yogurt. Production describes the process of turning inputs (milk, labor...) and through a process turn them into products (yogurts)
Capital is a factor of production that has been produced for use in the production of other goods and services. Which of the following are examples of capital?
airports computer software
An oil refinery has expanded to reach a refining capacity of 100 million cubic feet / day. As a result, total cost have increased rapidly and cost of refining per cubic foot has risen. The oil refinery is experiencing
diseconomies of scale. If a firm, as it expands, sees their average cost or cost per unit increase, it is experiencing diseconomies of scale not economies of scale.
What are three of factors of production?
labor, capital and natural resources
Marcie started a consulting firm, she is using an office building she used to rent for $60,000/year as her office. She purchased computers and other equipment for $25,000 and spent $20,000 on marketing and advertising. She also hired an assistant for $30,000/year and her other expenses such as utilities are $15,000. If Marcie worked for another firm, she would earn $100,000. Her revenue for the year were $150,000. Based on the information above, Marcie's accounting and economic profits are respectively ________.
$60,000 and (-$100,000) The economic profit is -$100,000 because you also have to count the forgone income as an implicit cost. Economic Profit = Total Revenue - Total Economic (implicit+explicit) cost = $150,000 - ($90,000+60,000+100,000) = -$100,000 it is an economic loss. Accounting profit = Total Revenue - Total explicit cost = $150,000 - $90,000 = $60,000
Production and Cost 2 main key takeaways
1. There are several different ways to look at production and costs, just like there are several different ways to look at a student's learning in a course. Students can be asked to write an essay or do a class presentation on a topic. These are two ways of trying to assess the same thing, student learning. 2. There is an inverse relationship between production and costs. The harder it is to produce something, for example, the more labor it takes, the higher the cost of producing it, and vice versa.
Which of the following represents a short run production story?
Paula hires an additional worker for a night shift to increase production on their existing packaging assembly line. Labor is a variable input and can easily be changed while the assembly line is fixed.
constant returns to scale:
expanding all inputs proportionately does not change the average cost of production
variable inputs
factors of production that a firm can easily increase or decrease in a short period of time
fixed inputs:
factors of production that can't be easily increased or decreased in a short period of time
A firm had sales revenue of $1 million last year. It spent $600,000 on labor, $150,000 on capital and $200,000 on materials. What was the firm's accounting profit?
$50,000
Market structure is a multidimensional concept that involves how competitive an industry is. It is defined by questions such as these:
- How much market power does each firm in the industry possess? - How similar is each firm's product to the products of other firms in the industry? - How difficult is it for new firms to enter the industry? - Do firms compete on the basis of price, advertising, or other product differences?
Which of the following example represents long run production?
Budget Airlines acquires a new plane to accommodate a growing number of customers. A new plane represents an increase in capital that will allow greater production and is therefore representative of the link run where changes in capital are possible.
Which of the following describes a fixed input for Carol's coffee shop?
Carol signs a new 3 year lease for the coffee shop. The lease will not be easy to change and would also not change whether production rises or falls.
Marcie started a consulting firm, she is using an office building she used to rent for $60,000/year as her office. She purchased computers and other equipment for $25,000 and spent $20,000 on marketing and advertising. She also hired an assistant for $30,000/year and her other expenses such as utilities are $15,000. If Marcie worked for another firm, she would earn $100,000. Her revenue for the year were $150,000. Marcie's implicit cost based on the information above is:
Marcie's potential market earnings ($150,000) and the foregone rent she is not collecting ($60,000)
Which of the following describes the production process?
The employees of Candle Inc are combining candle wax and colors and filling up molds for the new line of Christmas candles. Various resources (labor, materials, machines...) are being used to come up with a product (candles)
diseconomies of scale:
the long-run average cost of producing output increases as total output increases
The marginal cost curve is generally ________, because diminishing marginal returns implies that additional units are ________.
upward-sloping; more costly to produce
