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Production and Costs

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Last updated date: 13th Jul 2024
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Production and Costs - Introduction

Production and costs are a very important part of modern economics and are essential in determining a whole lot of things in production. We have to deal with various concepts like production function, cost of production, and the necessary mathematical terms that are associated with them. Being acquainted with all these terms would help us understand the various industries' operations in an economy. To begin with, we all know that production incurs a cost, which is the money spent on all the various factors of production. The relationship between the inputs and the output in the production process can be explained with the help of a production function.

Production Function

Production and costs can be explained with the help of the production function. The production function is just the function relationship between the various production factors and the output produced through this process. Arithmetically this is depicted as Q= f(L, K). The Q over here is the output, while ‘L’ and ‘K’ are the different inputs that go into the production process. There may be various other factors involved, but over here, we are working with a two-factor model.

Types of Costs in Economics

The different types of costs include fixed costs, variable costs, semi-variable costs, marginal cost, opportunity cost, economic cost, accounting costs, sunk cost, among other types of costs. Fixed costs refer to the costs that do not change with output—variable costs, on the other hand, are dependent on what is being produced and keep varying. Marginal costs refer to the cost of producing an additional unit of a particular commodity or service.

Time Period And Production Function

The total cost of production also depends on the period of production. In the short run, there is a relationship between the output and anyone variable factor. The long-run output is different from this and has all the various factors of production in the same proportion. The law that works in the case of the short-run output is called the law of returns to a factor, and the law that works in the case of the long-run output is called the law of returns to scale.

Total Product, Average Product, And Marginal Product

The production function is used to denote a physical relationship between the physical inputs and output. The total production refers to the total production by a firm in a given period. On the other marginal production is the additional one unit produced. On the other hand, the average product is the average of the total production per unit of a factor of production consumed. This is obtained by dividing the total product by the variable factors or the inputs that have gone into production. They help us to determine the cost of production.

Behaviour of Cost in The Short Run

In the short run, there are fixed inputs that cannot be changed. The short-run cost function is a relationship between the output and the cost of production. This explains how the cost of production changes with the change in the level of output if all other things remain unchanged. The Total fixed cost consists of the value of the various fixed inputs in production, and they do not change with any alterations in production or output. The total variable cost, on the other hand, refers to the cost of the varying factors of production and change with different levels of production. When production is zero, the total variable cost is also zero. The total cost is the addition of the total variable cost and the total fixed cost.

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Did You Know?

In the long run, all the different factors of production are variable, and the long-run total cost is just the minimum cost of production. This can be less or equal to the average costs in the short-run average cost. The long-run average cost curve is the average of the long-run total cost curve, or in other words, it is simply the cost per unit of output In the long run. The long-run marginal cost is the cost of an additional unit being produced in the long run, with all the factors of production being variable. 

Solved Example

  1. Why is the Long-Run Average Cost Referred to as the Envelope Curve?

Answer: The long-run average cost is the different producers' optimization problem, and the firm can operate in the long run. In contrast, all the different factors of production are variable. The firm tries to keep its cost minimum and the LAC that is derived by joining the different SAC curves, which are producing different levels of output. This causes an envelope curve.

FAQs on Production and Costs

1. What are the different types of costs in economics?

Costs are an essential part of economics, and whenever goods are produced, costs are incurred. However, these costs are of varying types and widely differ from one another. The fixed cost is incurred on fixed input, which does not change when the production level is changed. Thus, the fixed cost includes the cost of land or the cost of building and maintaining a factory. Variable costs, on the other hand, change with change in output and include the expenditure incurred on raw materials of productions like wood and metal. Marginal cost is the cost of an additional unit of output produced. These are the three basic types of cost.

2. Explain cost in the short run.

In the short run, various fixed factors cannot be changed. The cost incurred on these fixed factors consist of the total fixed cost and include fixed inputs like buildings or technology. The total variable cost, on the other hand, is costs that keep changing with different levels of output. Owing to this reason, when the production level is zero, the total variable cost is also nil, and this is the reason this curve starts from the origin. The total cost is simply the addition of the TFC and TVC, and when this is divided by the input, we get the average variable cost.