Topic 4 - Production Costs and Revenues

• Production


  Converts inputs, such as the services of factors of production from capital and labour, into a final output to satisfy consumer needs and wants
• Productivity


  Calculated by output per worker per period of time
• Being more productive


  The same input, such as the number of workers, produces more output, over the same period of time
• Being less productive


  Requires a larger input to produce the same quantity of output
• Ways to increase productivity


  • Training workers
  • Using more advanced capital machinery
• Being more productive


  Lowers average costs per unit of output
• Specialisation


  When each worker completes a specific task in a production process
• Adam Smith: 'Through the division of labour, worker productivity can increase'
• Division of pin production


  • One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper
• By dividing the production of pins into 18 different tasks, the output of pins could increase significantly
• Specialisation


  Can be achieved by individuals, businesses, regions of countries or countries themselves
• Advantages of specialisation


  • Higher output and potentially higher quality
  • Greater variety of goods and services produced
  • More opportunities for economies of scale
  • More competition and incentive for firms to lower costs
• Disadvantages of specialisation


  • Work becomes repetitive, which could lower worker motivation
  • More structural unemployment as skills might not be transferable
  • Variety could decrease for consumers
  • Higher worker turnover for firms
• Comparative advantage


  A country can produce a good at a lower opportunity cost than another country
• Absolute advantage


  A country can produce more of a good with the same factor inputs
• Advantages of trade based on comparative/absolute advantage


  • Greater world output, so there is a gain in economic welfare
  • Lower average costs, since the market becomes more competitive
  • Increased supply of goods to choose from
  • Outward shift in the PPF curve
• Disadvantages of trade based on comparative/absolute advantage


  • Less developed countries might use up their non-renewable resources too quickly
  • Countries could become over-dependent on the export of one commodity
• Medium of exchange


  Money eliminates the problem of double coincidence of wants in barter
• Measure of value (unit of account)


  Money provides a means to measure the relative values of different goods and services
• Store of value


  Money has to hold its value to be used for payment
• Method of deferred payment


  Money can allow for debts to be created
• Short run


  The scale of production is fixed (there is at least one fixed cost)
• Long run


  The scale of production is flexible and can be changed. All costs are variable
• Marginal return


  The extra output derived per extra unit of the factor employed
• Average return


  The output per unit of input
• Total return


  The total output produced by a number of units of factors (e.g. labour) over a period of time
• Law of diminishing returns


  The variable factor could be increased in the short run, but over time the labour will become less productive, so the marginal return of the labour falls
• Increasing returns to scale

  Output increases by a greater proportion to the increase in inputs
• Decreasing returns to scale


  A doubling of input leads to a less than double increase in output
• Constant returns to scale

  Output increases by the same amount that input increases by
• Fixed costs


  Costs which do not vary with output
• Variable costs


  Costs that change with output
• Total cost


  The cost to produce a given level of output, calculated as total variable costs + total fixed costs
• Average cost


  The cost per unit, calculated as total costs / quantity produced
• Marginal cost


  The cost of producing one extra unit of output
• Short run average total cost curve


  • U-shaped due to diminishing returns as factors of production are fixed
• Long run average cost curve


  • Initially falls due to economies of scale, then rises due to diseconomies of scale
• If factor inputs become more productive


  Firms can produce more output with a smaller input, resulting in lower unit costs of production
• As the average cost per unit of one factor input rises

  Firms are likely to switch to cheaper (and generally more productive) factor inputs
• Fixed costs


  Indirect costs that do not change with output