Production and Costs Costs of production Costs ... amazonaws com
Production and Costs Costs of production Costs are defined as those expenses faced by a business when producing a good or service for a market. Every business faces costs and these must be recouped from selling goods and services at different prices if a business is to make a profit from its activities. In the short run a firm will have fixed and variable costs of production. Total cost is made up of fixed costs and variable costs Fixed Costs These costs relate do not vary directly with the level of output. Examples of fixed costs include: 1. Rent paid on buildings and business rates charged by local authorities. 2. The depreciation in the value of capital equipment due to age. 3. Insurance charges. 4. The costs of staff salaries e.g. for people employed on permanent contracts. 5. Interest charges on borrowed money. 6. The costs of purchasing new capital equipment. 7. Marketing and advertising costs. Variable Costs Variable costs vary directly with output. I.e. as production rises, a firm will face higher total variable costs because it needs to purchase extra resources to achieve an expansion of supply. Examples of variable costs for a business include the costs of raw materials, labour costs and other consumables and components used directly in the production process. We can illustrate the concept of fixed cost curves using the table below. The greater the total volume of units produced, the lower will be the fixed cost per unit as the fixed costs are spread over a higher number of units. This is one reason why mass-production can bring down significantly the unit costs for consumers – because the fixed costs are being reduced continuously as output expands.
In our example below, a business is assumed to have fixed costs of £30,000 per month regardless of the level of output produced. The table shows total fixed costs and average fixed costs (calculated by dividing total fixed costs by output). When we add variable costs into the equation we can see the total costs of a business. The table below gives an example of the short run costs of a firm
Average Total Cost (ATC) is the cost per unit of output produced. ATC = TC divided by output Marginal cost (MC) is defined as the change in total costs resulting from the production of one extra unit of output. In other words, it is the cost of expanding production by a very small amount. Long run costs of production: The long run is a period of time in which all factor inputs can be changed. The firm can therefore alter the scale of production. If as a result of such an expansion, the firm experiences a fall in long run average total cost, it is experiencing economies of scale. Conversely, if average total cost rises as the firm expands, diseconomies of scale are happening. The table below shows a simple example of the long run average cost of a business in the long run when average costs are falling, then economies of scale are being exploited by the business.
Short Run Costs Fixed costs: Fixed costs are business expenses that do not vary directly with the level of output i.e. they are treated as independent of the level of production. Examples of fixed costs include the rental costs of buildings; the costs of leasing or purchasing capital equipment such as plant and machinery; the annual business rate charged by local authorities; the costs of full-time contracted salaried staff; the costs of meeting interest payments
on loans; the depreciation of fixed capital (due solely to age) and also the costs of business insurance. Fixed costs are the overhead costs of a business. They are important in markets where the fixed costs are high but the variable costs associated with making a small increase in output are relatively low. We will come back to this when we consider economies of scale.
Total fixed costs
Average fixed cost
(TFC) (AFC)
remain constant as output increases =
total fixed costs divided by output
Average fixed costs must fall continuously as output increases because total fixed costs are being spread over a higher level of production. In industries where the ratio of fixed to variable costs is extremely high, there is great scope for a business to exploit lower fixed costs per unit if it can produce at a big enough size. Consider the new Sony portable play station. The fixed costs of developing the product are enormous, but these costs can be divided by millions of individual units sold across the world. A change in fixed costs has no effect on marginal costs. Marginal costs relate only to variable costs!
In our example below, a business is assumed to have fixed costs of £30,000 per month regardless of the level of output produced. The table shows total fixed costs and average fixed costs (calculated by dividing total fixed costs by output). When we add variable costs into the equation we can see the total costs of a business. The table below gives an example of the short run costs of a firm
Average Total Cost (ATC) is the cost per unit of output produced. ATC = TC divided by output Marginal cost (MC) is defined as the change in total costs resulting from the production of one extra unit of output. In other words, it is the cost of expanding production by a very small amount. Long run costs of production: The long run is a period of time in which all factor inputs can be changed. The firm can therefore alter the scale of production. If as a result of such an expansion, the firm experiences a fall in long run average total cost, it is experiencing economies of scale. Conversely, if average total cost rises as the firm expands, diseconomies of scale are happening. The table below shows a simple example of the long run average cost of a business in the long run when average costs are falling, then economies of scale are being exploited by the business.
Short Run Costs Fixed costs: Fixed costs are business expenses that do not vary directly with the level of output i.e. they are treated as independent of the level of production. Examples of fixed costs include the rental costs of buildings; the costs of leasing or purchasing capital equipment such as plant and machinery; the annual business rate charged by local authorities; the costs of full-time contracted salaried staff; the costs of meeting interest payments
on loans; the depreciation of fixed capital (due solely to age) and also the costs of business insurance. Fixed costs are the overhead costs of a business. They are important in markets where the fixed costs are high but the variable costs associated with making a small increase in output are relatively low. We will come back to this when we consider economies of scale.
Total fixed costs
Average fixed cost
(TFC) (AFC)
remain constant as output increases =
total fixed costs divided by output
Average fixed costs must fall continuously as output increases because total fixed costs are being spread over a higher level of production. In industries where the ratio of fixed to variable costs is extremely high, there is great scope for a business to exploit lower fixed costs per unit if it can produce at a big enough size. Consider the new Sony portable play station. The fixed costs of developing the product are enormous, but these costs can be divided by millions of individual units sold across the world. A change in fixed costs has no effect on marginal costs. Marginal costs relate only to variable costs!
