The value of average costs. Average cost functions
The purpose of creating a business - opening a company, building a plant with the subsequent release of planned products - is to make a profit. But increasing personal income requires considerable costs, not only moral, but also financial. All monetary expenses aimed at producing any good are called costs in economics. To work without losses, you need to know the optimal volume of goods/services and the amount of money spent to produce them. To do this, average and marginal costs are calculated.
Average costs
With an increase in the volume of production, the costs dependent on it grow: raw materials, wage essential workers, electricity and others. They are called variables and have various addictions at different quantities release of goods/services. At the beginning of production, when the volumes of goods produced are small, variable costs are significant. As production increases, costs decrease due to economies of scale. However, there are expenses that an entrepreneur bears even with zero production of goods. Such costs are called fixed: utilities, rent, salaries of administrative staff.
Total costs are the sum of all costs for a specific volume of goods produced. But to understand the economic costs invested in the process of creating a unit of goods, it is customary to turn to average costs. That is, the quotient of total costs to output volume is equal to the value of average costs.
Marginal cost
Knowing the value of the funds spent on the sale of one unit of good, it cannot be argued that an increase in output by another 1 unit will be accompanied by an increase in total costs, in an amount equal to the value of average costs. For example, to produce 6 cupcakes, you need to invest 1200 rubles. It’s easy to immediately calculate that the cost of one cupcake should be at least 200 rubles. This value is equal to average costs. But this does not mean that preparing another pastry will cost 200 rubles more. Therefore, to determine the optimal volume of production, it is necessary to know how much money will be required to invest in order to increase output by one unit of the good.
Economists come to the aid of the firm’s marginal costs, which help them see the increase in total costs associated with the creation of an additional unit of goods/services.
Calculation
MC - this designation in economics has marginal costs. They are equal to the quotient of the increase in total expenses to the increase in volume. Since the increase total costs in the short term caused by an increase in average variable costs, the formula may look like: MC = ΔTC/Δvolume = Δaverage variable costs/Δvolume.
If the values of gross costs corresponding to each unit of production are known, then marginal costs are calculated as the difference between adjacent two values of total costs.
Relationship between marginal and average costs
Economic solutions for management economic activity must be accepted after marginal analysis, which is based on marginal comparisons. That is, comparison alternative solutions and determination of their effectiveness occurs by assessing the incremental costs.
Average and marginal costs are interrelated, and changes in one relative to the other are the reason for adjusting the volume of output. For example, if marginal costs are less than average costs, then it makes sense to increase output. It is worth stopping the increase in production volume in the case when marginal costs are higher than average.
The equilibrium situation will be in which marginal costs are equal to the minimum value of average costs. That is, there is no point in further increasing production, since additional costs will increase.
Schedule
The presented graph shows the company's costs, where ATC, AFC, AVC are the average total, fixed and variable costs, respectively. The marginal cost curve is denoted MC. It has a shape convex to the x-axis and at minimum points intersects the curves of average variables and total costs.
Based on the behavior of average fixed costs (AFC) on the graph, we can conclude that increasing the scale of production leads to their reduction; as mentioned earlier, there is an effect of economies of scale. The difference between ATC and AVC reflects the amount of fixed costs; it is constantly decreasing due to the approach of AFC to the x-axis.
Point P, characterizing a certain volume of product output, corresponds to the equilibrium state of the enterprise on the market. If you continue to increase volume, then costs will need to be covered by profits as they begin to increase sharply. Therefore, the company should settle on the volume at point P.
Marginal Revenue
One of the approaches to calculating production efficiency is to compare marginal costs with marginal revenue, which is equal to the increase Money from each additional unit of goods sold. However, the expansion of production is not always associated with an increase in profits, because the dynamics of costs are not proportional to volume and with an increase in supply, demand and, accordingly, the price decrease.
Marginal cost firms are equal to the price of the good minus marginal revenue (MR). If marginal cost is lower than marginal revenue, then production can be expanded, otherwise it must be curtailed. By comparing the values of marginal costs and income, for each value of output, it is possible to determine the points of minimum costs and maximum profit.
Profit maximization
How to determine the optimal production size to maximize profits? This can be done by comparing marginal revenue (MR) and marginal cost (MC).
Each new product produced adds to total income the amount of marginal revenue, but at the same time increases total costs by the amount of marginal costs. Any unit of output whose marginal revenue exceeds its marginal cost should be produced because the firm will receive more income, which will add to costs. Production is profitable as long as MR > MC, but as output increases, rising marginal costs due to the law of diminishing returns will make production unprofitable because they will begin to exceed marginal revenue.
Thus, if MR > MC, then production needs to be expanded if MR< МС, то его надо сокращать, а при MR = МС достигается равновесие фирмы (максимум прибыли).
Features when using the rule of equality of limit values:
- The condition MC = MR can be used to maximize profit in the case when the cost of the good is higher than the minimum value of average variable costs. If the price is lower, the company does not achieve its goal.
- Under conditions pure competition, when neither buyers nor sellers can influence the formation of the value of a good, marginal revenue is equivalent to the price of a unit of the good. This implies the equality: P = MC, in which marginal costs and marginal price are the same.
Graphical representation of a firm's equilibrium
Under pure competition, where price equals marginal revenue, the graph looks like this.
Marginal costs, the curve of which intersects the line parallel to the x-axis, characterizing the price of the good and marginal income, form a point showing the optimal sales volume.
In practice, there are times when doing business when an entrepreneur should think not about maximizing profits, but minimizing losses. This happens when the price of a good decreases. Stopping production is not the best option since fixed costs must be paid. If the price is less than the minimum value of gross average costs, but exceeds the value of the average variables, then the decision must be based on the output of goods in the volume obtained at the intersection of the marginal values (income and costs).
If the product price is purely competitive market has fallen to a level below the firm's variable costs, then management must take the responsible step and temporarily stop selling goods until the cost of an identical good increases by next period. This will trigger an increase in demand due to a decrease in supply. An example is agricultural firms that sell products in autumn-winter period, and not immediately after harvest.
Costs in the long run
The time interval during which changes in the production capacity of an enterprise can occur is called the long-term period. The firm's strategy must include cost analysis for the future. In the long time frame, long-term average and marginal costs are also considered.
With the expansion of production capacity, there is a decrease in average costs and an increase in volumes up to a certain point, then costs per unit of output begin to increase. This phenomenon is called economies of scale.
The long-run marginal cost of an enterprise shows the change in all costs due to an increase in output. The average and marginal cost curves relate to each other over time in a similar way to the short-term period. The main strategy in the long run is the same - it is determining production volumes by means of the equality MC = MR.
Every organization strives to achieve maximum profit. Any production incurs costs for the purchase of factors of production. At the same time, the organization strives to achieve such a level that a given volume of production is provided at the lowest possible cost. The firm cannot influence the prices of resources. But, knowing the dependence of production volumes on the number of variable costs, costs can be calculated. Cost formulas will be presented below.
Types of costs
From an organizational point of view, expenses are divided into the following groups:
- individual (expenses of a particular enterprise) and social (costs of manufacturing a specific type of product incurred by the entire economy);
- alternative;
- production;
- are common.
The second group is further divided into several elements.
Total expenses
Before studying how costs and cost formulas are calculated, let's look at the basic terms.
Total costs (TC) are the total costs of producing a certain volume of products. In the short term, a number of factors (for example, capital) do not change, and some costs do not depend on output volumes. This is called total fixed costs (TFC). The amount of costs that changes with output is called total variable costs (TVC). How to calculate total costs? Formula:
Fixed costs, the calculation formula for which will be presented below, include: interest on loans, depreciation, insurance premiums, rent, wages. Even if the organization does not work, it must pay rent and loan debt. Variable expenses include salaries, costs of purchasing materials, paying for electricity, etc.
With an increase in output volumes, variable production costs, the calculation formulas for which were presented earlier:
- grow proportionally;
- slow down growth when reaching the maximum profitable production volume;
- resume growth due to violation of the optimal size of the enterprise.
Average expenses
Wanting to maximize profits, the organization seeks to reduce costs per unit of product. This ratio shows a parameter such as (ATC) average cost. Formula:
ATC = TC\Q.
ATC = AFC + AVC.
Marginal costs
The change in total costs when production volume increases or decreases by one unit shows marginal costs. Formula:
From an economic point of view, marginal costs are very important in determining the behavior of an organization in market conditions.
Relationship
Marginal cost must be less than total average cost (per unit). Failure to comply with this ratio indicates a violation of the optimal size of the enterprise. Average costs will change in the same way as marginal costs. It is impossible to constantly increase production volume. This is the law of diminishing returns. At a certain level, variable costs, the calculation formula for which was presented earlier, will reach their maximum. After this critical level, an increase in production volumes even by one will lead to an increase in all types of costs.
Example
Having information about the volume of production and the level of fixed costs, you can calculate everything existing species costs.
Issue, Q, pcs. | Total costs, TC in rubles | ||||||
Without engaging in production, the organization incurs fixed costs of 60 thousand rubles.
Variable costs are calculated using the formula: VC = TC - FC.
If the organization is not engaged in production, the amount of variable costs will be zero. With an increase in production by 1 piece, VC will be: 130 - 60 = 70 rubles, etc.
Marginal costs are calculated using the formula:
MC = ΔTC / 1 = ΔTC = TC(n) - TC(n-1).
The denominator of the fraction is 1, since each time the volume of production increases by 1 piece. All other costs are calculated using standard formulas.
Opportunity Cost
Accounting expenses are the cost of the resources used in their purchase prices. They are also called explicit. The amount of these costs can always be calculated and justified with a specific document. These include:
- salary;
- equipment rental costs;
- fare;
- payment for materials, bank services, etc.
Economic costs are the cost of other assets that could be obtained from alternative uses of resources. Economic costs = Explicit + Implicit costs. These two types of expenses most often do not coincide.
Implicit costs include payments that a firm could receive if it used its resources more profitably. If they were bought in a competitive market, their price would be the best among the alternatives. But pricing is influenced by the state and market imperfections. That's why market price may not reflect the true cost of resources and may be higher or lower than opportunity costs. Let us analyze in more detail the economic costs and cost formulas.
Examples
An entrepreneur, working for himself, receives a certain profit from his activities. If the sum of all expenses incurred is higher than the income received, then the entrepreneur ultimately suffers a net loss. It, together with net profit, is recorded in documents and relates to obvious costs. If an entrepreneur worked from home and received an income that exceeded his net profit, then the difference between these values would constitute implicit costs. For example, an entrepreneur receives a net profit of 15 thousand rubles, and if he were employed, he would have 20,000. in this case there are implicit costs. Cost formulas:
NI = Salary - Net profit = 20 - 15 = 5 thousand rubles.
Another example: an organization uses in its activities premises that belong to it by right of ownership. Explicit expenses in this case include the amount of utility costs (for example, 2 thousand rubles). If the organization rented out this premises, it would receive an income of 2.5 thousand rubles. It is clear that in this case the company would also pay utility bills monthly. But she would also receive net income. There are implicit costs here. Cost formulas:
NI = Rent - Utilities = 2.5 - 2 = 0.5 thousand rubles.
Returnable and sunk costs
The cost for an organization to enter and exit a market is called sunk costs. Expenses for registering an enterprise, obtaining a license, payment advertising campaign no one will return it, even if the company goes out of business. In a narrower sense, sunk costs include costs for resources that cannot be used in alternative ways, such as the purchase of specialized equipment. This category of expenses does not relate to economic costs and does not affect Current state companies.
Costs and price
If the organization's average costs are equal to the market price, then the firm makes zero profit. If favorable conditions increase the price, the organization makes a profit. If the price corresponds to the minimum average cost, then the question arises about the feasibility of production. If the price does not cover even the minimum variable costs, then the losses from the liquidation of the company will be less than from its functioning.
International distribution of labor (IDL)
The world economy is based on MRI - the specialization of countries in the production individual species goods. This is the basis of any type of cooperation between all states of the world. The essence of MRI is revealed in its division and unification.
One production process cannot be divided into several separate ones. At the same time, such a division will make it possible to unite separate industries and territorial complexes and establish interconnections between countries. This is the essence of MRI. It is based on the economically advantageous specialization of individual countries in the production certain types goods and their exchange in quantitative and qualitative relationships.
Development factors
The following factors encourage countries to participate in MRI:
- Volume of the domestic market. U large countries There is more possibilities find the necessary factors of production and there is less need to engage in international specialization. At the same time, market relations are developing, import purchases are compensated by export specialization.
- The lower the state's potential, the greater the need to participate in MRT.
- High provision of the country with mono-resources (for example, oil) and low level provision of mineral resources encourages active participation in MRI.
- The more specific gravity basic industries in the structure of the economy, the less the need for MRI.
Each participant finds economic benefit in the process itself.
3. Average and marginal production costs
For entrepreneurs, it is important to measure average production costs.
Cumulative or gross average costs - ATC - (average total costs) - gross costs per unit of production:
Calculate similarly average constants (AFC) And average variable costs (AVC):
AFC = FC/Q; AVC=VC/Q; ATC = AFC+AVC
Figure 23. Graphs of average gross, average variable and average fixed costs curves.
Average fixed costs (AFC) decrease as the supply of products increases, since with an increase in production volume there will be less and less of them per unit of output. The average fixed cost curve is a hyperbola.
Average variable costs, initially quite high, begin to decline with increasing production volumes and reach their minimum at a certain volume, starting from which they grow due to the law of diminishing returns. Therefore, the average variable cost curve is a U-shaped line.
Average gross costs depend on average constants and variables. Initially, they, representing the sum of two decreasing functions, also decrease, but starting from a certain volume (greater than that at which the minimum of average variable costs is achieved), the decrease in average fixed costs begins to be covered by an increase in average variable costs, that is, the total average costs also begin to increase. The average gross cost curve is a U-shaped line located above the average variable cost curve.
The category is used to make decisions about the optimal volume marginal costs.
Marginal Cost MC Marginal costs are the additional costs required to produce an additional unit of output.
Figure 24. Graph of marginal cost curves
The marginal cost curve, like the two average cost curves described above, is U-shaped. When reading the chart you should pay attention to the following:
marginal costs are less than average costs as long as the latter decreases;
marginal costs are greater than average costs as soon as the latter begin to increase;
marginal costs are equal to average costs at production volumes that ensure minimum corresponding average costs.
4. Entrepreneurial capital.
Entrepreneurial capital.
Capital, various interpretations, essences and forms.
Both in everyday life and in economic theory, the concept
"capital" has many meanings.
different methodological approaches
different contexts
While exploring capital, K. Marx differentiated such concepts as:
constant capital - means of production; that is, means and objects of labor;
variable capital - funds used to attract labor;
money - money capital;
goods - commodity capital.
According to Marx, essence of capital determined by the following main points:
capital is not a thing, but certain public attitude, the relationship between the owner of the means of production and wage workers (in a single case) or (in a broader sense) the relationship between capitalists and wage workers;
capital is in constant movement, only then money or
material objects are transformed into capital;
capital is self-increasing cost, that is, money that brings in additional money.
Most economists consider capital as an economic resource(production factor), meaning, first of all, its natural form, the so-called physical capital. It means: machines, machines, buildings, structures, stocks of materials and raw materials, semi-finished products, etc.
In financial markets under capital understand money capital, that is, money that generates income in the form of interest.
To carry out entrepreneurial activities, it is necessary to invest capital. So to start a business you need
start-up capital, which represents the sum of the initially invested physical and monetary capital and current expenses at the initial stage of production.
Sources starting capital and entrepreneurial capital in general can be own and borrowed funds.
Own funds are the authorized capital, profit from core activities, profit from financial transactions, depreciation fund, debt of buyers for shipped goods, proceeds from the sale of disposed property, etc.
Authorized capital- this is the initial amount of capital of companies provided for by the charter or agreement on their foundation.
Borrowed funds- These are loans and advances.
Any national economic system includes a set of, on the one hand, isolated, and on the other, interconnected firms engaged in individual reproduction.
Individual reproduction is a continuously repeating process of productively combining economic resources to create goods and services and generate income.
The basis of individual reproduction is the circulation of capital.
Circulation of capital- this is a consistent change by capital of its functional forms: monetary, productive and commodity.
The circulation of capital can be described by the following formula:
RS
D-T............P.........T"-D"
1st stage 2nd stage 3rd stage
Each stage of the circuit performs a specific function.
At stage 1, they are formed production conditions.
At stage 2 it is carried out production goods and services.
At stage 3 it occurs implementation goods and services and making a profit.
In one cycle, as a rule, not the entire value of the invested capital is returned. In this regard, the concept of capital turnover is introduced.
Capital turnover is a set of continuously changing circuits, for which all advanced capital is returned to the entrepreneur in cash.
The turnover of various elements of capital occurs over different time periods. For this reason, capital is divided into fixed capital
and negotiable.
Working capital - This is part of the enterprise’s economic assets, the cost of which is transferred to the finished product in one production cycle (circulation). Working capital is
raw materials, materials and labor costs. The costs of these capital elements are recouped in one production cycle.
Basic capital is buildings, structures, etc. price
fixed capital is transferred to the finished product in parts, over several capital cycles (fixed capital is consumed only in a certain part during one production cycle).
The concepts of fixed and working capital given above reflect the understanding of these categories in domestic economy. They are also used in foreign economic theory and practice, but their interpretation is somewhat different from ours. This is due to the peculiarities of accounting reporting adopted in different countries.
Thus, in the book “Economics of the Firm” by Danish authors Vorst and Reventlow it is stated: “Fixed capital - These are assets designed to be used by an enterprise over a long period of time. .. Working capital refers to those assets that, during normal business activities, change their forms in a relatively short term(less than 1 year)...
main capital;
intangible assets;
money;
financial assets;
working capital;
inventory;
accounts receivable;
securities and other short-term financial investments; cash" 22 .
The process of transferring the value of fixed capital as it wears out during its service life to the finished product is called depreciation.
Depreciation is associated with the wear and tear of fixed capital. A distinction is made between physical and moral wear and tear.
Physical deterioration is a process as a result of which fixed capital becomes physically unsuitable for its further use. Physical wear and tear means destruction, breakage, etc. phenomena. It occurs both as a result of the productive use of fixed capital and during its idle time.
Moral wear - This is the process of depreciation of fixed capital due to obsolescence. Obsolescence can occur for the following two main reasons:
due to the creation of similar, but cheaper means of labor;
due to the release of more productive means labor at the same price.
The cost of depreciation of fixed capital, reimbursed in parts, accumulates in sinking fund. Depreciation deductions are intended for the repair or replacement of worn-out labor equipment.
In the conditions of modern high-tech production, it is extremely important to neutralize the obsolescence factor. In this regard, economically developed countries use a policy of so-called accelerated depreciation.
Before introducing the concept of accelerated depreciation, we point out that depreciation rate - This is the ratio of the annual amount of depreciation to the cost of fixed capital.
Example: To the main =1 million rubles, A=200 thousand rubles.
A’=------´100=20%
Accelerated depreciation - this is an increase in depreciation rates and an accelerated transfer of the cost of labor to produced goods and services in order to quickly update the production apparatus and neutralize the factor of obsolescence.
Accelerated depreciation is one of the most important means of state regulation of the economy. More information about accelerated depreciation should be read in the textbook "Economics", ed. Bulatova A.S.. M.: VEK, 1996. P.274-277
In conclusion, we will consider the most important indicators of the use of fixed and working capital.
A general indicator of the use of fixed capital is capital productivity (CR):
FO = ------ ,Where
P - cost of production;
To the main - the cost of fixed production assets (fixed capital).
Increasing capital productivity is desirable both for an individual business firm and for the national economy as a whole.
The use of working capital is reflected by the material intensity indicator (ME):
ME= ------- , where
To ob. - the cost of circulating production assets (working capital).
It is desirable both for an individual business firm and for the national economy as a whole. decreasing material consumption.
2.3.1. Production costs in a market economy.
Production costs – This is the monetary cost of purchasing the factors of production used. Most cost effective method production is considered to be one in which production costs are minimized. Production costs are measured in value terms based on the costs incurred.
Production costs – costs that are directly associated with the production of goods.
Distribution costs – costs associated with the sale of manufactured products.
The economic essence of costs is based on the problem of limited resources and alternative use, i.e. use of resources in this production excludes the possibility of using it for another purpose.
The task of economists is to choose the most optimal option for using factors of production and minimizing costs.
Internal (implicit) costs – These are monetary incomes that the company donates, independently using its resources, i.e. These are the income that could be received by the company for independently used resources under the best of conditions. possible ways their applications. Opportunity cost is the amount of money required to divert a particular resource from the production of good B and use it to produce good A.
Thus, the costs in cash that the company incurred in favor of suppliers (labor, services, fuel, raw materials) are called external (explicit) costs.
Dividing costs into explicit and implicit are two approaches to understanding the nature of costs.
1. Accounting approach: Production costs should include all real, actual expenses in cash (salaries, rent, alternative costs, raw materials, fuel, depreciation, social contributions).
2. Economic approach: production costs should include not only actual costs in cash, but also unpaid costs; associated with missed opportunities for the most optimal use of these resources.
Short term(SR) is the period of time during which some factors of production are constant and others are variable.
Constant factors are the overall size of buildings, structures, the number of machines and equipment, the number of firms that operate in the industry. Therefore, the possibility of free access of firms to the industry in the short term is limited. Variables – raw materials, number of workers.
Long term(LR) – the period of time during which all factors of production are variable. Those. During this period, you can change the size of buildings, equipment, and the number of companies. During this period, the company can change all production parameters.
Classification of costs
Fixed costs (F.C.) – costs, the value of which in the short term does not change with an increase or decrease in production volume, i.e. they do not depend on the volume of products produced.
Example: building rent, equipment maintenance, administration salary.
C is the amount of costs.
The fixed cost graph is a straight line parallel to the OX axis.
Average fixed costs (A F C) – fixed costs that fall on a unit of output and are determined by the formula: A.F.C. = F.C./ Q
As Q increases, they decrease. This is called overhead allocation. They serve as an incentive for the company to increase production.
The graph of average fixed costs is a curve that has a decreasing character, because As production volume increases, total revenue increases, then average fixed costs represent an increasingly smaller value per unit of product.
Variable costs (V.C.) – costs, the value of which changes depending on the increase or decrease in production volume, i.e. they depend on the volume of products produced.
Example: costs of raw materials, electricity, auxiliary materials, wages (workers). The main share of costs is associated with the use of capital.
The graph is a curve proportional to the volume of output and increasing in nature. But her character can change. In the initial period, variable costs grow at a higher rate than manufactured products. As the optimal production size (Q 1) is achieved, relative savings in VC occur.
Average variable costs (AVC) – the volume of variable costs that falls on a unit of output. They are determined by the following formula: by dividing VC by the volume of output: AVC = VC/Q. First the curve falls, then it is horizontal and increases sharply.
A graph is a curve that does not start at the origin. General character curve - increasing. The technologically optimal output size is achieved when AVCs become minimal (i.e. Q – 1).
Total costs (TC or C) – the totality of a firm's fixed and variable costs associated with producing products in the short term. They are determined by the formula: TC = FC + VC
Another formula (function of the volume of production output): TC = f (Q).
Depreciation and amortization
Wear- This is the gradual loss of capital resources of their value.
Physical deterioration– loss of the consumer qualities of the means of labor, i.e. technical and production properties.
A decrease in the value of capital goods may not be associated with their loss of consumer qualities; then they speak of obsolescence. It is due to an increase in the efficiency of production of capital goods, i.e. the emergence of similar, but cheaper new means of labor that perform similar functions, but are more advanced.
Obsolescence is a consequence of scientific and technological progress, but for the company this results in increased costs. Obsolescence refers to changes in fixed costs. Physical wear and tear is a variable cost. Capital goods last more than one year. Their cost is transferred to finished products gradually as they wear out - this is called depreciation. Part of the revenue for depreciation is formed in the depreciation fund.
Depreciation deductions:
Reflect an assessment of the amount of depreciation of capital resources, i.e. are one of the cost items;
Serves as a source of reproduction of capital goods.
The state legislates depreciation rates, i.e. the percentage of the value of capital goods by which they are considered to be worn out during the year. It shows how many years the cost of fixed assets must be reimbursed.
Average Total Cost (ATC) – the sum of the total costs per unit of production output:
ATS = TC/Q = (FC + VC)/Q = (FC/Q) + (VC/Q)
The curve is V-shaped. The production volume corresponding to the minimum average total cost is called the point of technological optimism.
Marginal Cost (MC) – an increase in total costs caused by an increase in production by the next unit of output.
Determined by the following formula: MS = ∆TC/ ∆Q.
It can be seen that fixed costs do not affect the value of MS. And MC depends on the increment of VC associated with an increase or decrease in production volume (Q).
Marginal cost shows how much it would cost the firm to increase output per unit. They decisively influence the firm’s choice of production volume, because This is exactly the indicator that the company can influence.
The graph is similar to AVC. The MC curve intersects the ATC curve at the point corresponding to the minimum value of total costs.
In the short run, the company's costs are fixed and variable. This follows from the fact that production capacity firms remain unchanged and the dynamics of indicators is determined by the increase in equipment utilization.
Based on this graph, you can build a new graph. Which allows you to visualize the company’s capabilities, maximize profits and view the boundaries of the company’s existence in general.
For making a firm's decision, the most important characteristic is the average value; average fixed costs fall as production volume increases.
Therefore, the dependence of variable costs on the production growth function is considered.
At stage I, average variable costs decrease and then begin to grow under the influence of economies of scale. During this period, it is necessary to determine the break-even point of production (TB).
TB is the level of physical sales volume over an estimated period of time at which revenue from product sales coincides with production costs.
Point A – TB, at which revenue (TR) = TC
Restrictions that must be observed when calculating TB
1. The volume of production is equal to the volume of sales.
2. Fixed costs are the same for any volume of production.
3. Variable costs change in proportion to the volume of production.
4. The price does not change during the period for which the TB is determined.
5. The price of a unit of production and the cost of a unit of resources remain constant.
Law of Diminishing Marginal Returns is not absolute, but relative in nature and it operates only in the short term, when at least one of the factors of production remains unchanged.
Law: with the increase in the use of a factor of production, while the rest remain unchanged, sooner or later a point is reached, starting from which the additional use of variable factors leads to a decrease in the increase in production.
The operation of this law presupposes the unchanged state of technical and technological production. And therefore, technological progress can change the scope of this law.
The long-run period is characterized by the fact that the firm is able to change all the factors of production used. During this period variable character of all used production factors allows the company to use the most optimal combinations of them. This will affect the magnitude and dynamics of average costs (costs per unit of production). If a firm decides to increase production volume, but by initial stage(ATS) will first decrease, and then, when more and more new capacities are involved in production, they will begin to increase.
The graph of long-term total costs shows seven different options (1 – 7) for the behavior of ATS in short-term periods, because The long-term period is the sum of the short-term periods.
The long-run cost curve consists of options called stages of growth. In each stage (I – III) the company operates in the short term. The dynamics of the long-run cost curve can be explained using economies of scale. The company changes the parameters of its activities, i.e. the transition from one type of enterprise size to another is called change in scale of production.
I – in this time interval, long-term costs decrease with an increase in the volume of output, i.e. there are economies of scale - a positive effect of scale (from 0 to Q 1).
II – (this is from Q 1 to Q 2), at this time interval of production, the long-term ATS does not react to an increase in production volume, i.e. remains unchanged. And the firm will have a constant effect from changes in the scale of production (constant returns to scale).
III – long-term ATC increases with an increase in output and there is damage from an increase in the scale of production or diseconomies of scale(from Q 2 to Q 3).
3. IN general view profit is defined as the difference between total revenue and total costs for a certain period of time:
SP = TR –TS
TR ( total revenue) - the amount of cash received by a company from the sale of a certain amount of goods:
TR = P* Q
AR(average revenue) is the amount of cash receipts per unit of product sold.
Average revenue is equal to the market price:
AR = TR/ Q = PQ/ Q = P
M.R.(marginal revenue) is the increase in revenue that arises from the sale of the next unit of production. Under perfect competition, it is equal to the market price:
M.R. = ∆ TR/∆ Q = ∆(PQ) /∆ Q =∆ P
In connection with the classification of costs into external (explicit) and internal (implicit), different concepts of profit are assumed.
Explicit costs (external) are determined by the amount of expenses of the enterprise to pay for purchased factors of production from outside.
Implicit costs (internal) determined by the cost of resources owned by a given enterprise.
If we subtract external costs from total revenue, we get accounting profit - takes into account external costs, but does not take into account internal ones.
If internal costs are subtracted from accounting profit, we get economic profit.
Unlike accounting profit, economic profit takes into account both external and internal costs.
Normal profit appears when the total revenue of an enterprise or firm is equal to total costs, calculated as alternative costs. The minimum level of profitability is when it is profitable for an entrepreneur to run a business. “0” - zero economic profit.
Economic profit(clean) – its presence means that there is this enterprise resources are used more efficiently.
Accounting profit exceeds the economic value by the amount of implicit costs. Economic profit serves as a criterion for the success of an enterprise.
Its presence or absence is an incentive to attract additional resources or transfer them to other areas of use.
The company's goals are to maximize profit, which is the difference between total revenue and total costs. Since both costs and income are a function of production volume, the main problem for the company becomes determining the optimal (best) production volume. A firm will maximize profit at the level of output at which the difference between total revenue and total cost is greatest, or at the level at which marginal revenue equals marginal cost. If the firm's losses are less than its fixed costs, then the firm should continue to operate (in the short term); if the losses are greater than its fixed costs, then the firm should stop production.
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In the classification of costs, in addition to fixed, variable and average, there is a category marginal cost. They are all interconnected; to determine the value of one type, you need to know the indicator of the other. Thus, marginal costs are calculated as the quotient of the increase in total costs and the increase in output. To minimize costs, that is, to achieve what every business entity strives for, it is necessary to compare marginal and average costs. What conditions of these two indicators are optimal for the manufacturer will be discussed in this article.
Types of costs
In the short term, when the influence economic factors realistically provide for, distinguish between fixed and variable costs. They are easy to classify because variables vary with the volume of goods produced, but constants do not. Expenses associated with the operation of buildings and equipment; salary of management personnel; payment for guards and cleaners is a monetary expenditure of resources that constitute fixed costs. Whether the enterprise produces products or not, you still have to pay for them monthly.
The salaries of the main workers, raw materials and materials are the resources that make up the variable factors of production. They vary depending on the volume of output.
Total costs are the sum of fixed and variable costs. Average expenses are the money spent on the production of one unit of a good.
Marginal cost shows the amount of money that must be spent to increase output by one unit.
Marginal cost schedule
The graph shows the curves of two types of costs: marginal and average. The point where the two functions intersect is the minimum average cost. This is no coincidence, since these costs are interconnected. Average costs are the sum of average fixed and variable costs. Fixed costs do not depend on production volume, and when considering marginal costs, one is interested in their change with an increase/decrease in volume. Therefore, marginal cost implies an increase in variable costs. It follows that average and marginal costs must be compared with each other when finding the optimal volume.
The graph shows that marginal costs begin to increase faster than average costs. That is, average costs are still decreasing with increasing volume, but marginal costs have already creeped up.
Balance point
Turning our attention to the graph again, we can draw the following conclusions:
- AC is located above MS, since it is a large value, including in addition to variables and fixed costs. While MS consists of an increase only in variable costs.
- The previous fact explains the right position of the AC relative to the MS. This is because per unit of volume growth, MC contains the difference in variable costs, and average costs (AC), in addition to variables, also include constant fixed costs.
- After the intersection of functions at the minimum point, an increase in marginal costs is observed faster than average. In this case, production becomes unprofitable.
The firm's equilibrium point in the market corresponds to optimal size production in which the economic entity receives a stable income. The value of this volume is equal to the intersection of the MS and AC curves at the minimum AC value.
Comparison of AC and MS
When marginal costs with volume growth are less than average costs, it is advisable for the company's top managers to make a decision to increase production.
When these two quantities are equal, equilibrium is achieved in the volume of output.
It is worth stopping the increase in output volume when the value of MC is reached, which will be higher than AC.
Average costs in the long run
All costs in the long run are characterized by a variable nature. A firm that has reached a volume at which average costs begin to rise in the long run is forced to begin changing factors of production that previously remained unchanged. It turns out that the total average costs are identical to the average variables.
The long-run average cost curve is a line that touches at the minimum points of the variable cost curves. The graph is shown in the figure. At point Q2 the minimum cost is achieved, and then it is necessary to observe: if there is negative effect scale, which is rare in practice, then at the volume in Q2 it is necessary to stop the increase in output.
Marginal revenue MR
An alternative approach in modern market economy To determine the volume of production at which costs will be minimal and profit will be maximum, we compare the values of the marginal values of income and costs.
Marginal income is the increase in funds that the enterprise receives from an additional unit of production sold.
By comparing the amounts that each additional unit of output added to total costs and gross income, one can determine the point of maximizing profit and minimizing costs, expressed by finding the optimal volume.
Analytical comparison of MS and MR
As an example, fictitious data from the analyzed company is presented below.
Table 1
Production volume, quantity | Gross income (quantity*price) | Gross costs, vehicle | Marginal Revenue | Marginal cost |
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Each unit of volume corresponds to a market price, which decreases as supply increases. The income generated by the sale of each unit of output is determined by multiplying the volume of output and the price. Gross costs increase with each additional unit of output. Profit is determined after deducting all costs from gross income. Limit values income and costs are calculated as the difference of the corresponding gross values from the increase in production volume.
Comparing the last two columns of the table, conclusions are drawn that when producing goods from 1 to 6 units, marginal costs are covered by income, and then their growth is observed. Even when producing goods in a volume of 6 units, maximum profit is achieved. Therefore, after a company increases production of a product to 6 units, it will not be profitable for it to increase it further.
Graphical comparison of MS and MR
At graphic definition The optimal volume is characterized by the following conditions:
- Marginal revenue above costs - expansion of production.
- Equality of values determines the equilibrium point at which maximum profit is achieved. Product output becomes stable.
- The marginal cost of production exceeds the marginal revenue - a sign of unprofitable production at a loss to the company.
Marginal cost theory
In order for an economic entity to make a decision to increase production volume, an economic tool such as a comparison of marginal costs with average costs and marginal revenue comes to the rescue.
If, in the usual sense, costs are the costs of producing products, then the marginal type of these costs is the amount of money that needs to be invested in production in order to increase the volume of output by an additional unit. When production is reduced, marginal cost shows the amount of money that can be saved.
