Tag Archives: cost

Short Run Production Costs

8 Jul


   Production information must contain resource prices in order to determine total and per unit price of diverse amount of output. It’s known that in short run prices are associated with plant’s variable resources. Its capital resources are limited so we shouldn’t consider them. Short run costs can be either variable or fixed. So let’s describe them:
Fixed Cost: these costs don’t vary with changes in output. These costs must be paid even if the firm doesn’t produce anything. Such costs may be: rental payments, interests of firm’s debts, money paid for insurance. These costs are paid even when the firm has zero output, so firm can’t avoid paying these costs.
Variable Cost:
 These costs vary with the change in output. They include payment for raw material, fuel, wages, transportation prices, fuel etc. These payments vary directly with output. As the production begins variable costs will increase by a decreasing amount, but after a point they will rise by an increasing amounts (as a result of law of diminishing marginal returns) also this reason lies in the shape of Marginal Product (MP) curve, which is increasing with smaller and smaller amounts and when diminishing returns are encountered marginal product begin to decline, so larger and larger amounts of variable resources are needed to produce a successive unit of output. Total variable cost then is increasing by an increasing amount.
Total Cost:
Economists call sum of fixed costs and variable costs as total costs. At zero unit of output total costs are equal with fixed costs. Graphically, amount of vertical Total Fixed Cost (TFC) summed with vertical value of Total Variable Cost (TVC) should result in Total Cost (TC).
For business manager these distinctions between fixed and variable costs are very important. Variable costs can be controlled or changed by changing production levels in short-run. However, fixed costs are beyond control of business manager, because they are included in short run and must be paid regardless the output level. In short run firms can’t get out of industry and leave the market.

 Per-unit and Average Costs:
 Average fixed cost (AFC) is found by dividing total fixed cost by output quantity (Q):
Average Fixed Cost Formula

Because Total fixed Cost by definition is the same regardless of output, then AFC curve will decline as output increases,because as output quantity increases Total Fixed Cost (TFC) is spread over a larger output produced. Q≠0.

Average Variable Cost (AVC): for any output quantity (Q≠0) is calculated by dividing Total Variable Cost (TVC) by Quantity output (Q):

Average Variable Cost
As added more variable resources increase output, average variable cost (AVC) declines initially, reach a minimum and then increases again, so AVC curve is U shaped. It can be explained by the fact that AVC (also TVC) curve reflects law of diminishing returns.

  To explain in simple terms, at very low levels of output, production is inefficient because of high-costs and low quantity produced. Initially, since firm is understaffed, average variable cost is relatively high. As output expands greater level of specialization, greater division of labor and better use of firm’s capital occurs. However, when we still add more variable resources, a point is reached when diminishing returns are incurred. Also the firm is being overstaffed so each additional unit of variable resource doesn’t increase marginal product (MP) as before.

    Average Total Cost (ATC) for any output level is found by dividing Total Cost (TC) by output (Q) or by adding average variable cost (AVC) and average fixed cost (AFC):
Average Total Cost Formula
Graphically ATC can be found by adding vertically average variable cost (AVC) and average fixed cost (AFC). Q≠0. 

Marginal Cost
  Marginal Cost is the additional cost of producing one more unit of output. Marginal cost can be found by following formula:
Marginal Cost formula
Marginal Cost is important for firm’s managers because a firm can control it immediately. It is used to find the cost of production of an additional product, so it helps to save some money if the firm doesn’t produce this unit (because of the loss that may occur at production).


Government and Trade

3 Jul

Protective tariffs

People and whole society benefits from specialization and international exchange, but why sometimes governments try to restrict the free flow of imports and encourage exports? What types of world trade barriers exist and why are they applied?

There are four methods by which government can restrict free flow of goods among its country and other nations:

  • Protective tariffs– are some taxes designated to protect domestic producers of goods and services from competition with foreign firms and producers. They cause a rise in the price of imported goods so that buyers will tend to purchase more domestic goods.
  • Import quotas– are limits on the quantities or total value of an item that may be imported in a period of time. If quota if “filled” that good or resource can’t be anymore imported. Import quotas are more effective than tariffs, because with tariffs that items can continue to be imported in large countries, but with quotas all imports are prohibited once quota is filled.
  • Export subsidies-represent government payments to domestic producers of some goods or resources. By offering this money, production costs are reduced, so these firms can lower prices of their products, so that they may sell more goods in world market.
  • Non-tariff barriers (also non-quota barriers)-include burdensome requirements, unreasonable standards related to product’s quality. Some nations require importers of foreign goods to have some type of license and then government restrict number of licenses issued. Some countries may use these inspects to examine if goods aren’t harmful for people’s health, other use them to impede imports.

Why government would impede free trade when it’s beneficial for a nation? Why would it increase quantity and value of exported goods and decrease value and quantity of imported ones?

There is a misunderstanding that greatest benefit from international trade is greater domestic employment in export sector. It’s commonly thought that exports are “good” because they increase employment, but imports are bad because they deprive people from their jobs. Actually the true benefit of free trade is that a nation can get a higher output of goods obtained after international specialization and exchange. A nation can fully employ its labor force and resources with or without international trade. However, international trade enables the society to use its resources in a way that increase the total output and well-being of society.

A nation doesn’t need international trade to operate on PPC. That’s why a non-trading society can have all labor force employed. But, with international trade a nation can reach a point that’s upper than PPC. The gains from trade are “extra-output” –they are production obtained with less cost than if it was produced home.

Political Consideration

While a nation whole gains from trade, it may harm some particular domestic industries or groups of people. These who benefit from import protection are few in number but with enormous authority. The overall costs of quotas and tariffs exceed the benefits. It’s known that if government spends 1 million on protecting an industry, the latter one doesn’t pay back even half of this amount. Since the costs are spread over large number of people the cost related to each demander of that good is quite small. Since public doesn’t know about this stuff it can be won by this political groups by apparent plausibility (“Decrease imports, and so prevent unemployment”) or with some patriotic slogans (“Buy only Australian”).

 Cost for the entire Nation

Tariff and quotas benefit domestic producers but they harm the domestic consumers, who shall pay higher that world prices for that goods and services. They also harm the domestic firms that use protected resources in their production of goods. With less competition from foreign countries, domestic firms may be less efficient at implementing cost-saving methods and improving the method of production.

Protective tariffs

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