MANAGERIAL MANAGERIAL ECONOMICSECONOMICS

PRODUCTION & COST PRODUCTION & COST ANALYSISANALYSIS

PRODUCTIONPRODUCTION

Production exchange and Production exchange and consumption of goods and consumption of goods and services are among services are among the basic economic activities of life.the basic economic activities of life.

A producer or a firm A producer or a firm acquires different inputs like labour, acquires different inputs like labour, machine, land, raw-material etc. Combining these machine, land, raw-material etc. Combining these inputs, it produces inputs, it produces output. This called the output. This called the process of production.process of production.

FACTORS OF PRODUCTIONFACTORS OF PRODUCTION

LandLand

LaborLabor

CapitalCapital

ManagementManagement

FUCTION OF PRODUCTIONFUCTION OF PRODUCTION

Total productTotal product

Average productAverage product

Marginal productMarginal product

COST COST ANALYSISANALYSIS

Cost Analysis:-Cost Analysis:- The economic cost that a firm incurs in

the production of a good refers to the payment it must to all the resources (factors of production)

employed by it in the production of that good.

The normal return on money capital invested by the entrepreneur him self in his own business which he could have earned if invested

outside. The cost of production of a firm changes with the changes in the output.

Types of costTypes of cost

Sunk cost :-

A sunk cost is an expenditure that has been incurred and cannot be recovered. All past costs are regarded as sunk cost. Sunk cost does not vary with the changes in the business activity for future it is unavoidable cost.

Future cost :-

Future cost is based on forecast it is relevant for most managerial decisions. Future cost may need expenditure on fixed on variable factors.

Indirect cost :- Cost which not directly

affect to the production or any individual final product.

Money cost:- When production cost is

expressed in terms of monetary unit it is called money cost.

Real cost :- The exertions of all the

different kinds of labour that are directly or indirectly involved in making it together required, for saving the capital used in making it, all these sacrifices together will be called the real cost of production of a commodity.

Direct cost :- Direct or prime cost is one can

be easily & directly identified to a particular product or plant.

Explicit cost :-

Explicit cost is the monetary payment made by the entrepreneur for purchasing or hiring the services of various productive factors, which do not belong to him. This cost is in the nature of contractual payment.

Implicit cost :-

Implicit cost arises in the case of those factors, which are possessed by the entrepreneur himself. It is cost of self owned, self employment resources that are frequently overlooked in computing the expenses of a firm.

Actual cost :-

Actual cost refers to the actual expenditure incurred for acquiring or producing a good or services.

Opportunity cost :-

Opportunity cost is the cost which is not actually incurred, but would have been incurred in the absence of employment of self owned factors.

Laws of Variable Laws of Variable Proportions or Laws of Proportions or Laws of Returns:-Returns:-

This is the modern version of the law of diminishing marginal returns. Under this law, it is assumed that only one factor of production is variable while other factors are fixed.

Prof. Benham state the law as follows :

“As the proportion of one factor in a combination of factors is increased after a point, the average and marginal production of that factor will diminish.”

Laws of Variable Laws of Variable Proportions or Laws Proportions or Laws of Returns of Returns

Three stages :

Increase in product at increasing rates. (Increasing return to variable factor)

Increase in product at constant rates. (Constant return to variable factor)

Increase in product at decreasing rates. (Diminishing return to variable factor)

Prof. Marshall : laws or returns, i.e., laws of increasing, constant and decreasing returns.

Laws of Variable Laws of Variable Proportions or Laws Proportions or Laws of of ReturnsReturns

Law of variable proportion is related to the short period – when with the increase in the units of a variable factor, MP increases, it is increasing returns, if MP remains constant, it is constant returns, and if MP decreases, it is the stage of diminishing returns.

Assumptions:-

Techniques of production does not change. Other inputs remain fixed Assumes that it is possible to change factor

proportions.

Units of Variable Input (labour)

Total Product

AverageProduct

Marginal Product

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10

205090120135144147148148145

20253030272421

18.516.414.5

20304030159310-3

Law of increasing returnsLaw of increasing returns

Causes of increasing return :

1. Increase in efficiency2. Fixed factors and fixed costs 3. Division of labour 4. Economies5. Before the point of optimum combination

Law of constant Law of constant returns:-returns:-

According to Marshall: “The stage of constant

returns comes at that point, where the effects of increasing returns and diminishing returns balance each other.”

Reaching a certain point (in the table 4th unit of labour is employed) a marginal product begins to diminish. Thus the rate of increase in the total product slows down. This is the stage of diminishing return.

Law of diminishing Law of diminishing returnsreturns

Causes for the operation of the law :-

1. Certain factors become fixed.2. Certain factors become scarce.3. Substitution of all the factors is not

available, and 4. Maximum optimum level of production has

already been achieved.

Law of returns to scaleLaw of returns to scale The relationship

between quantities of output and the scales of production in the long run, when all the inputs are increased in the same proportion, is called law of returns to scale.

Increasing return to scale – obtaining output at higher percentage than the percentage increase in the input by increasing the scale of production.

Constant return to scale.

Decreasing return to scale.

Differences between returns to a variable Differences between returns to a variable factor and returns to scalefactor and returns to scale

1. Period2. Change in factors3. Change in factor ratio4. Change in the scale of production

Causes of the operation of the law:

When internal and external economies exceed the diseconomies, the stage of increasing returns to scale operates; when economies and diseconomies are equal to each other, it becomes the stage of constant returns to scale; and when diseconomies exceed the economies, law of diminishing returns to scale is said to operate.

COST CURVESCOST CURVES

U-SHAPED LONG RUN U-SHAPED LONG RUN AVERAGE COST CURVEAVERAGE COST CURVE

A very large flat portion in the centre of A very large flat portion in the centre of long run average cost curve is depicted.long run average cost curve is depicted.

It arrives if the economies of scale are It arrives if the economies of scale are exhausted at a very modest scale of exhausted at a very modest scale of production and expansion in output, production and expansion in output, diseconomies of scale do not occur.diseconomies of scale do not occur.

Only after a very large increase in Only after a very large increase in output, diseconomies exert themselves output, diseconomies exert themselves and bring about a rise in the long run and bring about a rise in the long run average cost. average cost.

OUTPUT

COST

Y

X

LAC

U-SHAPED LONG RUN AVERAGE COST CURVE

L-SHAPED LONG RUN L-SHAPED LONG RUN AVERAGE COST AVERAGE COST CURVE CURVE

In the beginning when output is In the beginning when output is expanded through increase in plant size & expanded through increase in plant size & associated variable factors, cost per unit associated variable factors, cost per unit falls rapidly due to economies of scale.falls rapidly due to economies of scale.

Even after large scale of output, the long Even after large scale of output, the long run average cost does not rise; it may run average cost does not rise; it may either remain constant or it may go on either remain constant or it may go on falling slightly.falling slightly.

The long run average cost rapidly falls The long run average cost rapidly falls but after a point it remains flat but after a point it remains flat throughout or even slope gently throughout or even slope gently downwards. downwards.

y

x

LAC

OUTPUT

LONG RUNCOST AVERAGE

L-SHAPED LONG RUN AVERAGE COST CURVE

ECONOMIES OF SCALEECONOMIES OF SCALE

When a firm expands its size of When a firm expands its size of production by increasing all the production by increasing all the factors, it secures certain factors, it secures certain advantages known as economies advantages known as economies of production.of production.

TYPES OF ECONOMIESTYPES OF ECONOMIES

INTERNAL ECONOMIESINTERNAL ECONOMIES

1.1.Managerial economiesManagerial economies2.2.Marketing economiesMarketing economies3.3.Research economiesResearch economies4.4.Welfare economies Welfare economies

EXTERNAL ECONOMIESEXTERNAL ECONOMIES

1.1.Economies of informationEconomies of information2.2.Economies of disintegrationEconomies of disintegration3.3.Economies of concentrationEconomies of concentration4.4.Economies of welfareEconomies of welfare

DISECONOMIES DISECONOMIES OF SCALEOF SCALE

When expansion of firm’s output When expansion of firm’s output may lead to rise in costs and may lead to rise in costs and thus result diseconomies instead thus result diseconomies instead of economies. of economies.

DISECONOMIES OF SCALEDISECONOMIES OF SCALE

INTERNALINTERNAL1.1.Financial diseconomiesFinancial diseconomies2.2.Managerial diseconomiesManagerial diseconomies3.3.Risk taking diseconomiesRisk taking diseconomies

EXTERNALEXTERNAL1.1.Localisation diseconomiesLocalisation diseconomies

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