RELATION BETWEEN PRODUCTION AND COST
The economists frequently assumes
that the problem of optimum input combinations has been solved and conducts his
analysis of the firm in terms of its revenues and costs expressed as functions
of output. The cost function of the firm gives the functional relationship
between total cost and total output. If C represents total cost and Q
represents the level of the output, then the cost functions is represented as
C=C (Q). The same level of output can be produced with the help of different
cost combinations. The cost function gives the least cost combinations for the
production of different levels of output.
Cost functions are derived
functions. They are derived from the production functions, which describes the
available efficient methods of production at any particular point of time. The
cost function can be deduced from the inputs combinations of the firm. The
input prices of the two inputs of production labor (L) and capital (K) are
given to be constant as the wage rate (w) and rent (r), respectively. If L and
K are the amounts of the two inputs that are used for the production of the
output level Q, the firm will always select those combinations of the two
inputs, which lie on the expansion path. Along any expansion path the level of
output increases as we gradually depart from the origin. Within the
non-inferior zone of the factors of production, their total employment will
also increase as we move along the expansion path. Therefore we can say that
along any expansion path the demand for any factor of production will depend on
the level of output to be produced. So, if L and K are the amounts of the
factors of production and Q is the level of output then it can be said that L
and K are functions of Q.
That is,
L = g1(Q)
And, K
= g2(Q)
Now, following the equation of the
costs line, the total cost (C) for producing the output level Q is given by
C = L. w + K.r
or C = w. g1(Q) + r. g2(Q)
or C = C(Q).
Since, w and r are constant C is
only a function of Q. This function is called the total cost functions of the
firm. The function shows that the total cost of the firm depends on the output
to be produced. The costs function is deduced from the expansion path of the
firm.
The cost function derived from the
expansion path of the firm represents the cost function in its long run nature
as in this case we have assumed that both the factors of production are
variable.
A firm's cost curves are linked to its
product curves. Overt the range of rising marginal product marginal; cost if
falling. When marginal product is a maximum, marginal; cost is a minimum. Over
the rang4e of rising average product, average variable cost is falling. When
average product is a maximum, average variable cost is a minimum. Over the range
of diminishing marginal product, marginal cost is rising. And over the range of
diminishing marginal product, average variable cost is rising.
Source:
Addison-Wesley, Economics, 1997, 236
Cost Revenue Analysis and Market
Price determination analysis is based
on the demand and supply forces. These in turn depend on the revenue and the
cost of production respectively. Thus cost and revenue analysis is
indispensable. This analysis exhibit only the profits or losses earned by the
firm but also helps in output determination and production planning.
Distinguish between
i. Money, Real and Opportunity Costs.
ii. Fixed Cost and Variable Costs.
iii. Explicit Costs and Implicit Costs.
iv. Accounting costs and Economic Costs.
v. Past Cost and Future Cost.
And others
i.
Money, Real and Opportunity Costs
Money
costs mean
the aggregate money expenditure incurred by a firm on the various items
entering into the production of a commodity. Money costs relate to money
expenditure by a firm on factors of production, on wages and salaries paid to
labor, on machinery and equipment, for rent and insurance and payment to the
Government by way of taxes.
Real
costs of production is expressed not in money
but in efforts of workers and sacrifices of capitalists undergone in the making
of a commodity. According to Marshall,
it is, "The extent ions of all the different kinds of labor that are
directly and indirectly involved in making it, together with the abstinences or
rather the waiting required for saving the capital used in making it, all these
efforts and sacrifice together will be called the real cost of production of
that commodity, "Marshall had in mind the disability, pain and the
discomfort involved for labor when it is engaged in production and also of the
unpleasantness involved in saving and capital accumulation. The concept of real
cost though of some importance lacks precision since it is expressed in
subjective terms.
Opportunity
Cost. A
person cannot satisfy all his wants since the money at his disposal is limited
in supply. He has to choose between on thing and another. The satisfaction of
one want involves the sacrifice of another. The cost of production of any unit
of a commodity A is the value of the factors of production used in producing
that unit. The value of these factors of production is measured by the best
alternative use to which they might have been put, had a unit of A not been
produced. In other words, the cost of any factor in the production of a
particular good is the maximum amount which the factor unit could yield in the
production of other goods since the firm has to pay to owners of factor units
what these units can secure in alternative occupations, the costs are known as
alternative or alternative or opportunity costs.
The concept of opportunity cost is
applicable to the determination of value in internal and international trade.
But the main drawback of this concept in that is applicable to a specific
factor, that is which can be put to one single use. Since the factor is a
single use factor. It can have no alternative or opportunity cost. The
opportunity cost stands for the cost of producing one unit of a commodity in
terms of another that can be produced instead.
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