Costs of Production revision
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This document discusses costs of production and different market structures. It covers the key concepts of short run and long run costs, including fixed, variable and total costs. It also defines different market structures such as perfect competition, monopoly, monopolistic competition and oligopoly. It provides examples of each market structure and discusses their characteristics such as number of firms, entry barriers, pricing behavior and competition strategies.
Costs of Production revision
- 1. Costs of production© Unit 03 1RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 2. Prepared by; RASHAIN PERERA 077 059 37 52 rashainperera@gmail.com RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 2
- 3. INTRODUCTION Section 01 RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 3
- 4. Business objectives Profit maximization is the fundamental objective of a business Profit is the excess of income over expenses Income is mainly through selling goods and services There are various components of costs such as variable costs, fixed costs and overhead costs. 4RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 5. Other business objectives Maximizing earning per share Satisfying customers Quality products Continuous improvement Satisfactory service Business social responsibility (CSR) Growth and development Research and development AND other financial and non financial objectives 5RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 6. The production process Conversion of raw materials to finished goods could be simply known as the production process. Conversion process, transformation process are some of the similar terms that are used by various parties for production process 6RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 7. Production process involves inputs and its outcome could be termed as output Therefore it is clear that there’s a direct relationship between inputs and outputs This relationship could be shown in terms of the production function 7RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 8. Production Function The production function shows the relationship between the inputs and the outputs of a particular production process. The production function can be presented as below 8RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) Q = f{L/M, K}
- 9. In some processes some inputs might be fixed. For example if capital is fixed the production function could be re stated as RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 9 Q = f { L/M, K }
- 10. Short run Vs Long run
- 11. Short Run Short run is a time period in which both variable factors and fixed factors exists. In the short run some factors remain fixed while some of the factors can be changed in line with the requirement. For example suppose that you need to park 4 cars in your garden but you don’t have enough space to do so. In the short run you garden space remains fixed while in the long run you can change it either by buying the land next to your house or by building an underground car park 11RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 12. Long Run In the long run all factors are variable and no fixed factors can be seen 12RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 13. Variable factors Vs Fixed factors
- 14. Variable Factors Variable factors are the inputs/ factors which change if the activity level or output changes For example if we consider a tuition class, the tutorial cost would be variable 14RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 15. Fixed Factors These are the factors or inputs that stay the same or constant regardless of the output produced or activity level Considering the same example mentioned in the previous slide, the fixed factor is the building that is being used to deliver the lecture 15RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 16. SHORT RUN Section 02 RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 16
- 17. Short run production function 17RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) Q = f { L/M, K }
- 18. RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 18 TP MP AP
- 19. Law of diminishing marginal returns This says that proportion of one factor in a combination of factors is increased, after a certain point first the marginal then the average product of that factor will diminish In other words total output will increase at a decreasing rate when more and more variable factors are assigned to a fixed input Refer notes for graphical presentation 19RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 20. Short run revenue functions Revenue is the income gained by selling goods and services Key formulas; 20RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) TR = P X Qty AR= TR/Qty MR= change in TR/change in Qty
- 21. Short run cost functions There are 7 types of short run costs Fixed costs Variable costs Total costs Average fixed cost Average variable cost Average total cost Marginal cost 21RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 22. Fixed costs This is the cost that stays a same regardless of the output level RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 22 TFC Cost Qty
- 23. Variable costs The costs that changes with the activity level or output level RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 23 Cost Qty TVC
- 24. Total costs This is the totality of variable and fixed costs RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 24 TC = VC + FC
- 25. Average fixed costs RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 25 AFC = TFC / Qty Cost Qty TFC AFC
- 26. Average variable costs RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 26 AVC = TVC / Qty Cost Qty AVC
- 27. Average total costs RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 27 ATC = AFC + AVC Cost Qty AVC ATC AFC
- 28. Marginal costs RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 28 MC = Chg TC/Chg Q Cost Qty AVC ATCMC
- 29. Cost functions VS production functions 29RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 30. RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 30
- 31. Short run profit functions Profit the excess of revenue over expenditure Where TR is a function of price and quantity sold TC is a function of variable, fixed costs and overheads 31RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) Profit = TR - TC
- 32. Types of profits Accountants profit Economists profit 32RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) = TR – explicit costs = TR – implicit – explicit costs
- 33. Explicit costs Explicit costs are the costs that can be accountant in monetary terms. For example electricity paid 10 000 Implicit costs These are the opportunity costs or unseen decision costs. 33RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 34. Types of economic profits Normal profit The minimum required by a firm to be in operation Here the economic profit = 0 Abnormal profit/supernormal profit This is an excess Here economic profit > 0 Subnormal profit Is an actual loss Here economic profit < 0 34RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 35. LONG RUN Section 03 RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 35
- 36. Long run production function Is a time period where only variable factors exists Long run production function can be explained with the help of economies of scale Economies of scale refers to an advantageous situation derived by a firm with increase in capacity, size and production 36RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 37. Envelop curve It is said that LRAC is made of several SRAC curves. LRAC is derived by joining the optimums of those SRAC curves as shown below. 37RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) LRAC SRAC 1 SRAC 2
- 38. Economies of scale and LRAC curve 38RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) Optimum level EOS DEOS
- 39. Returns to scale and LRAC curve 39RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) Increasing returns to scale constant returns to scale Decreasing returns to scale
- 40. Increasing returns to scale Firms experience this if their average cost per unit in production falls as the firms expand in size/ activity level Reasons Bulk buying Spreading overheads Risk bearing economies Financial economies Marketing economies of scale Specialization 40RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 41. Decreasing returns to scale Reasons Depreciation of resources Stress Lack of control Poor communications in the large firm Weaknesses in the management and coordination. 41RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 42. MARKET STRUCTURES Section 04 RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 42
- 43. Characterization of markets Number of firms? Size of firms? Type of product? Barriers to entry and exit? Information availability? RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 43
- 44. Perfect competition Characteristics Large number of small firms Homogenous or identical product No/low barriers to entry and exit Perfect information available for both consumers and producers No advertising can be seen A price taker Faces a perfectly elastic demand curve No/low competition Ex; paddy farmers, wheat farmers etc 44RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 45. Industry VS firms demand curve (price taker) 45RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) Industry Firm P S D P=D=AR=MR
- 46. Price = demand = AR = MR 46RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) Price Demand TR AR MR 10 1 10 10 10 10 2 20 10 10 10 3 30 10 10 10 4 40 10 10 P=D=AR=MR 10
- 47. 47RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) D=AR=MR=P MC AC Short run equilibrium- abnormal profit
- 48. 48RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) D=AR=MR=P MC AC Short run equilibrium-sub normal profit
- 49. 49RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) D=AR=MR=P MC AC Long run equilibrium- normal profit
- 50. 50RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) D=AR=MR=P MC AC Shut down point- case 1 since AVC can be covered the firm will continue its operations AVC
- 51. 51RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) D=AR=MR=P MC AC Shut down point- case 2 since AVC can not be covered the firm will shut down or discontinue AVC
- 52. 52RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) D=AR=MR=P MC AC Supply curve of a perfect competitive firm- case 1 AVC
- 53. 53RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) MC AC AVC Supply curve of a perfect competitive firm- case 2
- 54. Monopoly Characteristics Only one firm Sells a unique product High entry and exit barriers Less or no information available for customers No need to advertise Faces a normal downward sloping demand curve A price maker No competition Ex; CGR 54RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 55. MR=0.5AR 55RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 56. Short/long run equilibrium-abnormal profit 56RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) D=AR MR MC AC
- 57. Monopolistic competition Characteristics Large number of small and large firms Homogenous or heterogeneous product Barriers to entry and exit are comparatively high Imperfect information Faces a normal downward sloping demand curve Advertising can be seen Can be a price taker or a maker Brand competition can be seen Ex; soft drinks, soap, tooth paste 57RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 58. Short run equilibrium-abnormal profit 58RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) D=AR MR MC AC
- 59. Long run equilibrium-normal profit 59RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) D=AR MR MC AC
- 60. Oligopoly Characteristics Few large firms Differentiated inter dependent product High barriers to entry and exit Mutually interdependent Advertising can be seen Faces a kinked demand curve High competition Ex; television broadcasting, newspaper publishers 60RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 61. Kinked demand curve 61RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 62. Competition methods Price competition Decreasing the price to increase sales discounts Non price competition Advertising Internet shopping Extension of opening hours Home delivery Cash on delivery COD 62RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 63. Price leadership When one firm has a dominant position in the industry, that firm will be able to control the prices of other firms in the industry up to a certain extent. The dominant firm is named as price leader. 63RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 64. The bad of oligopolies Inefficient in allocation of resources In equal distribution of income The good of oligopolies Widen the product range Benefits the customer with innovative products Can take advantage of economies of scales 64RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 65. Types of barriers to entry and exit Barriers to entry Economies of size Capital intensive Intellectual property High switching cost of barriers Established brand loyalty Legal requirements Government standards Barriers to exit Investment in specialized equipment Specialized skills High fixed costs 65RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt)
- 66. END RASHAIN PERERA CIMA Adv. Dip. MA, UOR (Mgt) 66