Production and Cost: An Overview

Introduction to Production and Cost

• This chapter covers the basics of production, production functions, short-run features, and production stages.
• The chapter also covers the distinction between economic and accounting costs, short run cost function characteristics, and the relationship between short run production functions and costs.
• By the end of this unit, students should be able to describe productivity, explain types of inputs and outputs, and analyze types of production costs.

Definition of Production, Inputs, and Outputs

• Production combines inputs to create outputs for consumption, contributing to individual utility.
• Inputs are economic resources like labor, capital, land, and entrepreneurial ability used in producing goods and services.
• Outputs transform inputs into usable forms, providing consumer satisfaction and resulting from the production process.
• Tangible outputs are physical products that can be touched (e.g., buildings, machinery).
• Intangible outputs are non-physical products with value (e.g., insurance, consultancy).
• Fixed inputs cannot be varied during a period (e.g., building, machinery)
• Variable inputs can be changed during a period (e.g., raw materials, labor).

Periods of Production

• This section helps students describe short-run and long-run production and differentiate Total Product, Average Product, and Marginal Product
• Production periods are distinguished based on the flexibility of economic resources.
• The two periods of production are known as the short run and the long run.
• Short run: At least one input is fixed, while others are variable with output increases achieved by increasing variable inputs like labor and raw materials.
• Long run: All inputs are variable and there are no fixed inputs, firms can install plants or construct new factory buildings and all production factors are variable.
• Short run and long run do not necessarily refer to specific time periods, but refer to the economic arrangement of inputs.
• Total Product (TP) is the overall output produced over a given period, expressed as Quantity (Q).
• Average Product (AP) is calculated by dividing total output by the number of workers employed, and also indicates labor productivity.
• Marginal Product (MP) is the increase in output from using one additional unit of a single factor input, while holding other factors constant.
  • MPL = ΔΤΡ/A L
  • Where, ATP stands for change in total production
  • AL stands for change in labor input

Cost of Production

• Here, students can define the cost of production and differentiate between types of costs.
• Production and cost are closely linked with the production cost referring to monetary outlays, or total expenditures and sacrifices during production and distribution.

Types of Cost of Production

• Explicit costs: Monetary payments or cash outlays to outside suppliers of inputs or resources, called accounting costs.
• Implicit costs: Values of non-purchased resources owned and used by firms, such as the salary of an owner-manager.
• Economic cost equals implicit costs plus explicit costs.
• Accounting cost is the monetary value of purchased inputs used in production while ignoring non-purchased inputs.
• Fixed costs are costs that don't change with output level or are always incurred even without production (e.g., rents, interest).
• Variable costs are those that directly vary with the level of output and increase as output rises (e.g., raw materials, wages).
• Total cost (TC) is the sum of Total Fixed Cost (TFC) and Total Variable Cost (TVC).
• Average Total Cost (ATC) is the total cost per unit of output, calculated as TC/Q, it can be divided into average variable cost (AVC) and average fixed cost (AFC).
• Marginal Cost (MC) refers to the additional cost from producing one more unit of output.