Firms have many costs associated with their production output levels. These include fixed, variable costs and total costs, which is a summation of the former two. As the names suggest, a fixed cost does not alter with the output level, whereas the variable cost does. The equation linking these three are;
Costs can be given either in the long run or the short run. The short run is a period of time where at least one of a firm’s inputs is fixed. On the other hand, the long run is a period of time where all inputs are variable. (Mansfield et al., 2003).
A cost function is a mathematical formula used to calculate costs at a specific level of output. Firms may want to use a cost function so they are able to forecast their production expenses.
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In this case, the firm needs to increase the amount of labour workers. Increasing capital wouldn’t increase output levels, as it is a fixed cost. However, if the firm continues to increase the number of workers, it will eventually get to a point where each additional worker will produce a smaller return. This is called the law of diminishing returns. (Salvatore, 2002). This law of diminishing returns helps to explain the shape of the variable cost curve, so it also explains the shape of the average variable cost curve. In graph 3, the variable cost curve is shown to have …show more content…
So, the firm will designate the medium machine size to produce q2 and the small machine size to produce q1. The firm makes these decisions to reduce the cost of production. This is why the long run average cost function is an envelope of all the short run average cost functions. In this example I only used 3 different sizes of machines but in real life there would multitude of different size machines, all with differing minimum average costs. (Perloff, 2014).
Graph 10 shows the equilibrium of marginal costs, average costs and the output price. Point E shows the normal profit of a firm. For a firm to survive in a competitive market it must produce this normal profit. Normal profit is sometimes called economic profit. To produce supernormal profit a firm must increase its output price level so the interception between the price level and the marginal cost curve is higher. Supernormal profit is extra profit made on top of the normal profit.
Profit cannot be maximized if the output price is below the minimum of the short run average cost curve because below this curve a firm’s costs to produce a product will be greater than what the firm sells the product
The average cost maintains the full cost of the objective divided by the number of units of provided service while the marginal cost refer to the additional cost incurred as a result of providing one more service unit (Finkler et al., 2013). The fixed cost refrains from changing based on changes in volume of service units while variable cost, on the opposite end, varies in cost based on changes in volume of service units (Finkler et al.,
Cost management plays a major role when maintaining profit margins. Management must be able to find in which areas of a business costs must be reduced and the consequences that such reductions have in the overall company. In some situations management must change the way the work is being done in order to decrease costs while in other cases changing one supplier for another might be enough, in both situations a tradeoff will occur and the consequences will impact the company as a whole.
A couple of Squares has a limited capacity for which to produce their products and smaller companies tend to have larger fixed costs than bigger companies. Therefore, A Couple of Squares must maximize profits in order to ensure that they will stay in business. A profit-oriented pricing objective is also useful because of A Couple of Squares’ increased sales goals. A Couple of Squares increased their sales goals due to recent financial troubles. Maximizing profits is the easiest way to meet these sales goals due to the fact that A Couple of Squares has limited production capacity. The last key consideration favors a profit-oriented pricing objective because A Couple of Squares offers a specialty product. A specialty product often has limited competition, therefore can be priced on customer value. Pricing at customer value will maximize profits as well as customer satisfaction. A Couple of Squares’ lack of production capacity, increased sales goals, and specialty product favor a profit-oriented pricing
Parkin et al. (2013: 239) states that a firm’s short-run decision is a time frame, in which the quantity of one factor of production or more is fixed. The factors of production of firm are divided into two categories, from which fixed and variable costs are distinguished. The fixed factors are the firm’s factory, namely land, capital and entrepreneurship and the variable factor is labour. SABMiller are planning to retrench fo...
1) Total Variable Costs are 60% of Total Costs; While the other 40% are from fixed costs.
No single firm can influence market price in a competitive industry; therefore a firm’s demand curve is perfectly elastic and price equals marginal revenue. Short-run profit maximization by a competitive firm can be analyzed by comparing total revenue and total cost or applying marginal analysis. A firm maximizes its short-run profit by producing that output at which total revenue exceeds total cost by the greatest amount.
Rishinek, A., 1983. Control Aspects of Standard Costing: Variance Analysis, Inflation Adjustment, The Learning Curve and their Computer Applications. Managerial Finance, 9(1), pp. 14-18.
shaped more like a straight line (Graph 2). As an example, let’s say that two brands of wine are produced, Brand A and Brand B. These two brands of wine use the same grapes and the production process is the same. The only thing that is different is the name on the label. The same factors of production can produce either brand equally efficiently. If an increase in production of Brand B goes from 0 to 3 bottles, the production of Brand A must be decreased by 3 bottles. In this case, the two products are almost identical and can be produced equally efficiently using the same resources. The opportunity cost of producing one over the other remain constant between the two extremes
Total cost is all of the expenses incurred in the production of a product, to include fixed and variable costs. Fixed costs, are expenses that are constant and do not change from month to month regardless of the amount of products sold. For instance, the rent of the factory is considered a fixed cost, for the reason that, the rent must be paid whether products are produced and sold or not. Variable costs,
cannot sustain this level of abnormal profits in the long run due to competitive pressures since other firms are free to enter and exit the industry and often firms enter and " eat into" the abnormal profit of. the monopolistic producers, as shown in the graphs below. In an oligopoly, firms are interdependent, e.g. as shown in the graph. below, if firm X decides to lower its price from B to D, sales should increase from A to C but since firms are interdependent, other firms would retaliate and lower their prices, too. So for firm X sales would increase only by AE, not AC.
In the short-run profit maximization would lead to supernormal profits. In the long-run with there being freedom to enter the market a leftward shift of the demand curve (AR) and marginal revenue (MR) curve. This is where the demand curve is tangential to the LRAC curve as seen in figure
Every company has some kind of Revenue and they all have costs that are associated with running the company. It is also true that if a company wants to increase their Revenue, their costs will increase too. It is every company’s goal to maximize revenue and either through Production or Services, and minimize cost. These things are easy to figure out, but actually identifying the production and figuring out how it will increase or decrease with change is very difficult.
For example: with the increase of the number of products produced, the cost of operating a machine also increase. Second we have batch level costs which is associated with batches; producing a multiple units of the same product that are processed together is called a batch. The third type is product level costs which arise from any activity in order to support the production of products. The fourth and the last type is facility level costs, this costs cannot be determined with a particular unit, product or batch; this costs are fixed with respect to batches, products and number of units produced. A single measure of volume is used for allocating costs to each service or product in traditional method for example: direct material cost, machine hours, direct labor cost and direct labor hours. A cost driver is an activity that generate costs, it can be generated by two types of costs the first is a particular machine 's running costs where the costs is driven by production volume as machine hours; the second is quality inspection costs where the cost is driven by the number of times the relevant activity occurs as the number of
As such, there is material cost regulator, manufacturing control, labor cost regulator, excellence control and so on. Conversely, control over the price is implemented through the methods of financial control and typical costing (Meigs, 1998). The control methods aid the management in understanding the operating competence of a firm. Cost accounting also determines the selling price. The intention of all business firms is minimizing costs and maximizing profits. The costs incurred in producing goods and services may be reduced through incorporating alternate but cheaper resources of
There is a simple rationalisation behind all this: there is a reduction in the average cost of production of a particular product, as a consequence of an increase in the firm’s experience. The time and cost of producing a unit of output will be reduced, as learning economies, economies of scale, economies of scope, etc. appear due to the cumulative output increase and other process related growth.