Cost of Production
Download as DOCX, PDF0 likes223 views
Cost of production theory states that the price of an object is determined by the sum of the costs that went into making it, including costs of labor, capital, land, and taxation. There are different types of costs such as fixed costs which do not change with business activity, variable costs which do change with activity, average costs which are total costs divided by output, and marginal costs which are the change in total costs from producing one more unit. Average costs affect supply and demand curves and can be plotted on a cost curve graph. In the long run, when all inputs can be varied, the typical long-run average cost curve is U-shaped, reflecting increasing then decreasing returns to scale.
Cost of Production
- 1. COST OF PRODUCTION The cost-of-productiontheoryof value isthe theorythatthe price of an objector conditionis determinedbythe sumof the cost of the resourcesthat wentintomakingit.The cost can comprise any of the factorsof production (includinglabor,capital,orland) and taxation. TYPES OF COST Fixedcosts are expensesthatdonotchange inproportiontothe activityof a business, withinthe relevantperiodorscale of production.Forexample,aretailermustpayrentand utilitybillsirrespective of sales. Variable costs by contrast change inrelationtothe activityof a businesssuchassalesorproduction volume. Average cost isequal tototal cost dividedbythe numberof goodsproduced. Marginal cost is the change intotal cost thatarises whenthe quantityproducedchangesbyone unit.In general terms,marginal costat eachlevel of productionincludesanyadditional costsrequiredto produce the nextunit.So,the marginal costsinvolvedinmakingone more woodentable are the additional materialsand laborcostincurred. Sunk costs are those that cannot be recoveredif afirmgoesout of business. AVERAGE COST (EXPLAIN) Average costor unitcost is equal to total cost dividedbythe numberof goodsproduced(the output quantity,Q).Itis alsoequal tothe sumof average variable costs(total variablecosts dividedbyQ) plus average fixed costs(total fixedcosts dividedbyQ).Average costsmaybe dependentonthe time period considered(increasingproductionmaybe expensiveorimpossible inthe shortterm, forexample). Average costsaffectthe supplycurve andare a fundamental componentof supplyand demand. Short-run average cost will varyinrelationtothe quantityproducedunlessfixedcostsare zeroand variable costsconstant.A cost curve can be plotted,withcostonthe y-axisandquantityonthe x-axis. Long-run average cost The long runis a time frame inwhichthe firmcan vary the quantitiesusedof all inputs,evenphysical capital. A long-runaverage costcurve can be upwardsloping,downwardsloping,ordownwardsloping at relativelylow levelsof outputandupwardslopingatrelativelyhighlevelsof output,withanin- betweenlevelof outputatwhichthe slope of long-runaverage costiszero.The typical long-runaverage
- 2. cost curve is U-shaped,bydefinitionreflectingincreasingreturnstoscale where negativelyslopedand decreasingreturnstoscale where positivelysloped. SHORT RUN All productioninreal time occursinthe shortrun. The short run isthe conceptual time periodinwhich at leastone factor of production isfixedinamountandothersare variable inamount.Coststhat are fixed,sayfromexistingplantsize,have noimpactona firm'sshort-rundecisions, since onlyvariable costs andrevenuesaffectshort-runprofits. LONG RUN The long run is the conceptual time periodinwhichthere are no fixedfactorsof production asto changingthe outputlevel bychangingthe capital stock or by enteringorleavinganindustry. The long run contrastswiththe short run,in whichsome factorsare variable andothersare fixed,constraining entryor exitfroman industry. The longrunis the periodwhenthe general price level,contractual wage rates,and expectationsadjustfullytothe state of the economy,incontrast to the shortrun whenthese variablesmaynotfullyadjust