Production and Cost

Introduction: Production and Cost

Production is the process via which inputs are changed into outputs. Usually, it is a manufacturing firm that is responsible for production. A manufacturing enterprise obtains different inputs, such as raw materials, machinery, and labor, and uses them to produce the finished goods or products. These finished goods are called outputs. Outputs may be consumed by consumers or it can be used as an input again to produce some other outputs.

For example, the producer of wheat may use fertilizers, land, labor, pesticides, etc. to produce wheat. An automobile manufacturer may use machinery, steel, labor, aluminum, rubber, etc. to produce a vehicle. Similarly, a manufacturer of a refrigerator may use machinery, steel, labor, and other inputs to produce a fridge.

Using definite simplifying presumptions, we may reiterate that production is instant in our model. That is, there is no time gap between the combination of inputs and the production of outputs. That means that once the production is finished we get the output from the used inputs instantly. In this case, the terms supply and production can be used identically. They can often be used conversely as well.

It is notable that the manufacturing firm has to pay to obtain inputs. The payment for machinery, labor, land, or other things that are used to produce a finished good is known as the cost of production. Once the product is finished it is sold in the market to obtain revenues. The difference between the revenue and cost of production is known as profit. Usually, manufacturing firms tend to derive maximum profit from their products which can be done by minimizing the production cost and maximizing revenues.

Types of Production Costs

There are three major types of production costs which are the following −

• Fixed cost − The fixed costs, as is obvious, do not change with changing production levels. Employee wages and costs of equipment usually do not change with changing the number of units of products. These are therefore called fixed costs.

• Variable cost − Variable costs are the costs that change with additional inputs. Examples of variable costs include the cost of raw materials, labor, machinery, etc. It is important to keep variable costs under control because they often tend to go beyond assumptions when accurate calculations are not done.

• Marginal cost − Marginal cost refers to the cost of producing an additional unit of a product. It may be considered as the cost each new unit of product requires for production. According to economic theory, firms expand their productions until the marginal cost of a product equals marginal revenue which tends to equalize the selling price in return.

Note − There may be situations in which the production cost of producing a product goes below the selling price of the product. The first thing firms should do in such circumstances is to lower production costs by all means possible. However, if the production costs cannot be lowered and they remain above the selling price for a continued time, producers must suspend producing the product until the production costs go below the selling price again.

Product Function

Production costs can be expressed in terms of product functions. These functions are relationships between factors of production and the outputs obtained via the processes.

Arithmetically this is expressed as $\mathrm{Q\:=\:f\:\lgroup\:L,K\:\rgroup}$

Where Q is the output, and ‘L’ and ‘K’ are the different inputs of the production process.

There may be numerous other factors involved, but here, we consider only a two-factor model.

Product function is usually dependent on the time period of production too. In the case of the short run, the relationship between output and only one function is considered while in the case of the long run, the relationship with all the production factors and output is considered. The law working in the case of the short run is known as the law of returns to a factor while that in the case of the long run is known as the law of returns to scale.

Short-run Behavior of Costs

Inputs remain unchanged in the short run. So, the function of production in this case is a relationship between the production cost and the output. It shows the behavior of costs because it expresses the variability of production cost with the level of output when all other factors remain constant. The total fixed cost of production remains unchanged. It does not change with a change in production factors or output levels. The total variable cost however varies with alterations in inputs and hence the total output also changes depending on the product functions. When the value of production is zero, the total variable cost is also equal to zero. The total costs on the other hand are the added sum of total variable and fixed costs.

Total, Average, and Marginal Products

Like production costs, products can also be divided into various types. Total product refers to the total production of a manufacturing unit in a given period of time. Average product is the number of average products produced by each unit of production factor. Marginal product is each additional product produced with each extra unit of production factors. Notably, the average product is obtained by dividing total products by the total inputs that are used in production.

Key Takeaways

• Production is the process via which inputs are changed into outputs.

• It is notable that the manufacturing firm has to pay to obtain inputs.

• The payment for machinery, labor, land, or other things that are used to produce a finished good is known as the cost of production.

• There are three major types of production costs which are fixed cost, variable cost, and marginal cost.

• According to economic theory, firms expand their productions until the marginal cost of a product equals marginal revenue which tends to equalize the selling price in return.

• Production costs can be expressed in terms of product functions. These functions are relationships between factors of production and the outputs obtained via the processes.

• Like production costs, products can also be divided into total, average, and marginal products.

Conclusion

Production and costs are two of the most important concepts of economics because no form can exist without having an idea of them. As the ideas of production and related costs are needed to set the price of a product, it is an indispensable tool that helps organizations remain aware of their profitability. This is why knowing about production and costs is important.

FAQs

Qns 1. What is meant by production? Discuss briefly.

Ans Production is the process via which inputs are changed into outputs. Usually, it is a manufacturing firm that is responsible for production. A manufacturing enterprise obtains different inputs, such as raw materials, machinery, and labor, and uses them to produce the finished goods or products. These finished goods are called outputs.

Qns 2. How many types of costs of production are there?

Ans. There are three major types of production costs - fixed, variable, and marginal costs.

Qns 3. What are production functions?

Ans. Production costs can be expressed in terms of product functions. These functions are relationships between factors of production and the outputs obtained via the processes.