Production and ProductivityChapter 9

Gross Domestic ProductThe production of the U.S. economy is

measured by the level of Gross Domestic Product (GDP).

GDP is the final value of all goods and service produced within a country in a year. It is measured by the U.S. Dept. of Commerce.

GDP is calculated using today’s current prices.

When GDP is reported in today’s current prices, it is called nominal GDP.

When GDP has been adjusted for inflation, it is called real GDP.

Gross Domestic ProductTo adjust GDP for inflation, a GDP

deflator is used. A GDP deflator is a price index that reduces current prices into prices of a base year.

So that we can compare GDP between countries and as countries grow, we often look at per capita GDP, which is taking GDP and dividing it by the population of the country.

Gross Domestic Product

GDP does not include:◦Intermediate items◦Resold items◦Goods produced by not sold◦Goods produced but consumed by

producer◦The value of leisure time◦Illegal activities

GDP does measure productivity of a nation

ProductivityProductivity is the output of

goods and services measured per unit of input by labor, capital, or land. ◦When productivity increases, more or

better products are produced with the same amount of resources.

◦Per capita GDP increases only when the production of goods/services grows faster than the population

Labor Productivity

Improvements productivity can be achieved by:

Changing the quality of training and education

Hiring workers with good work ethics and attitudes

Changing the quality of management and management training◦Including an emphasis on customer

satisfaction, high-quality work, and employee decision making.

Production and Cost ChangesCosts vary when the level or

speed of production changes.◦Fixed costs – costs that remain the

same regardless of the amount of product a firm produces (depreciation, engineering, taxes, salaries)

◦Variable costs – costs that change with changing amounts of production (wages, electrical power, chemicals, raw materials)

CostsAverage Fixed Costs – total

fixed costs divided by quantity produced

Average Variable Costs – total variable costs divided by quantity produced

Total Costs– the sum of total fixed costs and total variable costs

AverageTotal Costs– the sum of average fixed costs and average variable costs

CostsThe additional cost of increasing a unit

of production is called marginal cost. ◦Marginal cost is the change in total cost

from one level of production to another. ◦This is cost that producers should watch; it

helps them decide at what level they should be producing.

◦When costs begin to increase, the producer should STOP producing.

◦This concept is called Diminishing Marginal Returns.

The Law of Diminishing Marginal ReturnsThis law says that, as more and

more variable resources are added to a fixed amount of other resources, the additional amount produced eventually decreases and leads to increasing costs.

This occurs because variable resources crowd out the other resources making it impossible to produce an unlimited amount with scarce resources.

How Much To Produce?Businesses are trying to

maximize profit. They can use marginal costs to

determine at what level they should produce.

Total Revenue is the calculation of revenue that is determined by price times quantity sold. There are often many combinations of prices and quantities available to management teams and choosing the best one can be difficult.

PricingManagers can experiment with

prices/production combinations, but that can be time consuming. The best recommendation is to engage is marginal analysis.

Marginal Analysis is decision making that involves comparing marginal (additional) benefits and marginal costs.

When marginal cost and marginal revenue are as close as possible, the profit is maximized.

Economies of ScaleEconomies of Scale are the

reductions in costs resulting from large-scale production.

Firms that enjoy economies of scale ◦enjoy the ability to specialize, ◦buy in bulk, ◦take part if large program or

processes, ◦and provide opportunities to their

employees