Production and Cost
Wessels (2012) notes that in economics production is the combination of raw material with inputs in order to come up with a consumable product or service that adds to the utility of a consumer. Cost of production on the other hand is considered to be the cost a firm incurs during production of a product or service. Rittenberg et al. (2008) suggest that the choice of factor of production used is important when it comes to factors of production efforts. In their book Principles of Microeconomics chapter eight centers on production and cost. This paper will be a review of Chapter Eight of the book. This review will look to relate production and cost from an economist point of view.
The chapter begins by indicating the reason why firms (organization that produce services and goods) get involved in production and what the factors of production are. Production involves use of land, labor and natural resources to come up with goods and services. Firms go through production in order to make profits and would want to make as much profit as possible. One way to ensure that a firm can get the maximum profit is through the reduction of cost of production. This chapter aims to look at ways that firms can achieve to reduce cost of production. According to economists, firms always use the marginal decision rule as they aim to make the maximum profit.
The chapter focuses on some of the expressions associated with short run production and cost in the short run. Mentioning of concepts like negative, increasing and diminishing marginal returns is also significant in the books chapter. Short run is defined in the article as a period when a firm decides that one or more factors of productions are considered fixed in quantity. A good example is a premise used as a clothing store, it can be considered as the fixed factor of production for six month or a year and therefore any plans made by a firm will consider that the firm will not move for six months or a year.
The beginning of the article also touches on other terms such as fixed factor of production which refers to a factor of production whose quantity cannot be changed for a time. The opposite of fixed factors is variable factor of production which is factors whose size can be altered during a given time. This chapter of the article states that long run is the opposite of short run where all factors of productions can be considered as variables. In this chapter of the article argument about increasing diminishing and negative marginal returns continue. Increasing marginal returns is related to the increase of labor while other factors of production remain constant. It is not labor alone that can affect increasing marginal returns. What this means that as labor is increased, more products will be produced. In the increasing marginal returns it’s all about addition to the total output compared to the previous unit. Unlike the increasing marginal returns, diminishing marginal returns is associated with the addition of less output to total output compared to the previous unit. If an employee produces two pairs of gumboots and the additional employee produces one. A negative marginal return is experienced by an organization when there is total reduction of production while all the factors of production are persistent.
The second part of the chapter focuses on production choices and cost that companies create in the long run. Corporations can decide to alter all the factors in terms of quantity in the long run. Firms can also decide to mix the factors of production if it finds it appealing. Firms are also at liberty to decide the overall size of its production activities. One notable difference with the short run operations is that all the factors of productions are variable when it comes to the long run; thus firms can expand anytime on the use of its factors. Chapter eight also talks about firms and the use of factors of productions to produce a lot at a low price. Firms define what they need to create and how much they need to create. At the same time firms realize that for them to get the maximum profit; they need to produce a lot at a cheaper cost (Parkin, 2012). One way that a firm can achieve to produce a lot in terms of output at low cost is through substitution. According to chapter eight, a firm can decide to add on one factor and reduce on another factor that will see production increase while cost remains the same. For instance if the cost of labor increases, a firm can decide to adopt a strategy that will see the rise in terms of capital but less as far as labor is concerned. Capital intensive is when a firm prefers to add more in the use of capital than labor, while labor sensitive is when a firm decides to use add more on labor compared to the capital ratio.
This part of the chapter looks at definition and causes of economies and diseconomies of scale. An economies of scale is what a firm increases its output while its long-run average cost increases. On the other hand diseconomies of scale are experienced by a firm when there is no change in the long-run regular cost over the productivity range. Specialization can help a firm to experience economies of scales by expanding the scale of the production operations hence an increase in productivity. As firms embrace mass production then a firm can experience low cost of production per unit. Meanwhile diseconomies of scales are a product of poor management in a business. When firm activities of production expand, it becomes more difficult for a manager to follow and manage and coordinate all the processes. The chapter concludes by noting the effect of economies and diseconomies of scales on the size of firms that can function in a market. In summary for a production to be complete factors of production like land, labor and capital must be present. Firms’ main reason for production is to make profit and they will always look for ways to make the maximum profit. One way of making profits is to increase production output while reducing the cost of production. Firms can minimize cost of production by use of marginal decision rule by choosing its factor mixing. Firms can either experience economies of scales, diseconomies of scale or constant returns to scale. How well a firm can do in a market is based on economies of scale, constant return to scale and diseconomies of scale.
Parkin, M. (2012). Economics. Boston: Addison-Wesley.
Rittenberg, L., Rittenberg, Libby., Tregarthen, Timothy D., & Flatworld Knowledge. (2008). Principles of microeconomics. Nyak, New York: Flatworld Knowledge.
Wessels, W. J. (2012). Economics. Hauppauge, N.Y: Barron’s Educational Series.