Lecture: PRODUCTION COSTS AND PROFIT OF A FIRM.
Production costs: concept and types.
The behavior of the company in the short and long term.
Revenues and profits of the company.
Production costs: concept and types.
If the buyer, when purchasing a product on the market, is primarily interested in its usefulness, then for the seller (manufacturer), production costs occupy a central place. In microeconomics, the time factor plays an important role. Therefore, before characterizing costs, we introduce the concepts of short-term and long-term periods of time.
Short-term (or short) period- this is a period of time during which some factors of production are constant, while others are variable. Fixed factors of production include resources such as the overall size of buildings and structures, the number of machines and equipment used, etc., as well as the number of firms operating in the industry . It is assumed that the opportunities for free access of new firms to the industry in the short term are very limited. In the short term, the company has the opportunity to vary only the degree of utilization of production capacity (by changing the length of working hours, the amount of raw materials used, etc.).
Long-term (long) period- this is the period of time during which all factors are variable. In the long run, a firm has the opportunity to change the overall size of buildings and structures, the number of machines and equipment used, etc., and the industry - the number of firms operating in it. The long run is the period during which barriers to entry and exit from an industry are overcome.
Production costs- the total costs of producing a product or service in monetary terms.
Production costs are divided into:
individual- individual entrepreneur, company;
public- for production, environmental protection, training of qualified labor, scientific development;
production- for the production of goods and services;
appeals- related to the sale of manufactured products;
external (explicit)- resources purchased by the company (accounting costs);
internal (implicit, or implicit)- the company’s own resources (not reflected in the financial statements).
Internal and external costs are economic costs of the company. A firm's economic costs also include normal profit- this is the minimum profit that keeps an entrepreneur in a given industry.
Costs are classified in various ways. Thus, from the point of view of an individual enterprise (firm), a distinction is made between explicit and implicit costs.Explicit (external) costs - cash payments that an enterprise (firm) makes to suppliers of production factors in the case when these factors do not belong to it. Explicit costs include wages paid to employees, commission payments to trading firms, payments to banks and other financial service providers, transportation costs, depreciation of equipment, costs of raw materials and supplies, etc.These are accounting costs. Implicit (implicit, internal) costs - the cost of services of factors of production that are used but not purchased, or this is the opportunity cost of using resources owned by the owners of firms that are not received in exchange for explicit (monetary) payments. Thus, if the owner of a small company works alongside the employees of this company without receiving a salary, then he thereby refuses to receive a salary by working somewhere else. Implicit costs are usually not reflected in financial statements. Establishing the distinction between explicit and implicit production costs is necessary to understand the types of profit.Normal profit - this is the minimum payment that the owner of the company must receive so that it makes sense for him to use his entrepreneurial talent in this field of activity. Lost income from the use of own resources and normal profit in total form internal costs. That's why,economic costs is the sum of explicit and implicit costs.
Production costs in the short term are divided into:
constant (FWITH)- their value does not change depending on changes in production volume. They exist even if the company does not produce anything. Includes: payments of interest on loans and borrowings, rent, depreciation, property tax, insurance premiums, salaries to management personnel and specialists of the enterprise (firm);
variables (V.C.) - vary directly depending on the volume of production. They are associated with the costs of purchasing raw materials and labor. The dynamics of variable costs is uneven: starting from zero, as production grows, they initially grow very quickly; then, as production volumes further increase, the factor of economy in mass production begins to affect, and the growth of variable costs becomes slower than the increase in production. Subsequently, however, when the law of diminishing returns comes into play, variable costs again begin to outpace production growth. In the long run, all costs are variable;
gross (total) (TS) is the sum of fixed and variable costs for each given volume of production (TC = FC + VC). A graphical representation of FC, VC, TC is shown in Fig. 1;
WITH
VС
Fig.1. General, fixed and variable costs.
average general (ATS or AC)- costs per unit of production (AC = TC / Q). At first, the average costs are quite high. This is due to the fact that large fixed costs are distributed over a small volume of production. As production increases, fixed costs fall on more and more units of output, and average costs quickly fall to a minimum at point K (Fig. 2). As production volume grows, the main influence on the value of average costs begins to be exerted not by fixed, but by variable costs. . Therefore, due to the fact that as production volume increases, the profitability of the resources used decreases, the curve begins to go up;
average variables (AVWITH)- variable costs per unit of production;
average constants (AFWITH)- fixed costs per unit of output;
limit (MS)- the cost of producing an additional unit of output. They show how much it will cost the enterprise to increase production volume by one unit or how much can be “saved” by reducing production volume by this last unit (MC = TCn – TCn- 1 = ΔTC / ΔQ = ΔVC / ΔQ).
The behavior of the company in the short and long term.
There is a close relationship between average variable cost, average total cost, and marginal cost. The marginal cost curve MC (Fig. 2) intersects the average cost curve AC at point K, and the average variable cost curve ABC at point B, which have a minimum value.
WITH MS AU
A.F.C.
Rice. 2. The relationship between average and marginal costs.
This can be explained as follows: if the marginal costs MC are less than the average costs AC, the latter decrease (per unit of output). This means that average total cost will fall as long as the marginal cost curve is below the average cost curve. Average costs will rise as long as the marginal cost curve is above the average total cost curve. The same can be said in relation to the curves of marginal and average variable costs - MC and AVC. As for the average fixed cost curve AFC, there is no such dependence here, because the marginal and average fixed cost curves are not related to each other.
Initially, marginal cost will be lower than average and average variable costs. However, due to the law of diminishing returns, they will begin to exceed both of them as production progresses. As a result, it becomes obvious that it is not economically profitable to further expand production.
Analysis of production costs in the long run is based on the fact that only variable costs change, i.e. dependent on production volume.
For long term The concepts of total and average costs are relevant, and here it is no longer possible to divide them into constant and variable. All costs of an enterprise (firm) are variable.
Figure 3 shows the long-term average cost curve (AC L), which consists of sections of short-term cost curves (AC 1, AC 2, etc.) in relation to various sizes of those enterprises that can be built. It shows the lowest cost per unit of production with which any volume of production can be achieved, provided that the enterprise has had sufficient time at its disposal to make the necessary changes in the size of the enterprise. Consequently, the firm determines the maximum volume of production at the lowest cost.
A.C. L
Q 1 Q 2 Q 3 Q 4 Q 5 Q
Fig.3. Long-run average cost curve.
Revenues and profits of the company.
Using resources for the production and sale of products, the entrepreneur receives income, which depends on the volume of products sold and market prices.
There are total, average and marginal income. Total (gross) income - the total amount of cash revenue received by a company from the sale of its products. The amount of total income depends on the volume of output (sales) and sales prices. Average income- this is the amount of cash revenue per unit of products sold. Marginal Revenue- income received as a result of the production and sale of an additional unit of product. Comparison of marginal revenue and marginal costs is used by commodity producers to make decisions on production development. As long as marginal revenue exceeds marginal cost and gross revenue exceeds gross cost, increasing output generates profit.
Profit is the difference between income on the one hand and costs, including mandatory payments to the state (taxes and similar payments), on the other.
Profit performs the following functions:
1) economic, which lies in the fact that profit is a reward to the owners of capital for providing it to organize the production of a product;
2) risky, which consists in rewarding the entrepreneur for the risks that always accompany entrepreneurial activity;
3) functional, which consists of rewards for technical, product and organizational innovations aimed at improving production.
The main forms of profit are economic and accounting profit . Accounting profit- part of the company’s income that remains from the total revenue after compensation for explicit (external, accounting) costs, i.e. fees for supplier resources. With this approach, only explicit costs are taken into account and internal (hidden) costs are ignored. Economic or net profit- part of the company’s income that remains after subtracting all costs (external and internal, including the entrepreneur’s normal profit) from the total income of the company.
The market mechanism also uses other forms of profit: gross, balance, normal, marginal, maximum, monopoly. Gross profit- the company’s total profit from sales and non-operating income . Balance sheet profit- the total amount of profit minus the losses incurred by the company (profit from sales plus net non-operating income (fines received minus those paid, interest on a loan received minus those paid, etc.)). Marginal profit is defined as the difference between marginal revenue and marginal cost. This is the profit per additional individual unit of production. For the company, this is a benchmark for increasing production volume. Maximum profit- the highest profit when comparing gross income and gross costs. The firm will receive the maximum absolute amount of profit at such a volume of production when gross income exceeds gross costs by the maximum amount. Monopoly profit- this is the profit received by a monopolist firm on the basis of limiting competition, respectively, production of products with an increase in price. Monopoly profits are typically higher than average profits and are obtained through the redistribution of income among firms.
Every business is interested in maximizing its profits. There are two ways to determine the possible maximum profit of an enterprise.
1). The first way is to compare marginal revenue (MY) and marginal cost (MC) of a product. Obviously, marginal revenue will decrease as the volume of production of a good increases. The reason for this is the law of demand, since the more goods we want to sell, the lower prices must be set for this product. Marginal costs will gradually increase as the cost of inputs for production will increase as the enterprise increases the demand for them (the greater the demand, the higher the price, with constant supply). In addition, the productivity of resources decreases, since initially any enterprise uses the highest quality and most productive factors of production, and then all the other, less productive ones.
WITH MS
Rice. 3. The relationship between average and marginal costs.
Obviously, as long as marginal revenue is greater than marginal cost, gross (total) profit will increase and reach a maximum at the point of intersection (equality) of marginal revenue and marginal cost. When marginal cost becomes greater than marginal revenue, total profit will begin to decline. Therefore, the condition for maximum profit will be the equality of marginal revenues and marginal costs.
M.Y.= M.C.
2) The second method is based on dividing costs into fixed (FC) and variable (VC). If you need to determine the volume of production that is needed for the enterprise to break even (profit is zero), then you can use the formula:
Q= F.C./(P- AVC)
Since the difference between P (price of a product) and AVC (average variable cost per unit of product) gives income without taking into account fixed costs per unit of product (it is called marginal income), it is obvious that profit will be zero when the total amount of marginal income Q(P-AVC) will be equal to fixed costs.
Q= (FC+In)/(P- AVC)
In this case, the resulting volume must be compared with the market capacity, that is, estimate the amount of money that consumers are willing to spend on a given product, and divide this amount by the price of the product.
PRODUCTION COSTS AND THEIR TYPES.
Each production unit (enterprise) of any society strives to obtain the greatest possible income from its activities. Any enterprise tries not only to sell its goods at a favorable high price, but also to reduce its costs of production and sales of products. If the first source of increasing an enterprise's income largely depends on the external conditions of the enterprise's activities, then the second - almost exclusively on the enterprise itself, more precisely, on the degree of efficiency of the organization of the production process and the subsequent sale of manufactured goods.
Many economists have made significant contributions to the study of costs. For example, K. Marx’s theory of costs is based on two fundamental categories - production costs And distribution costs. Production costs mean the costs of wages, raw materials and materials, this also includes depreciation of labor instruments, etc. Production costs are the production costs that must be incurred by the organizers of the enterprise in order to create goods and subsequently make a profit. In the cost of a unit of goods, production costs make up one of its two parts. Production costs are less than the cost of the product by the amount of profit.
The category of distribution costs is associated with the process of selling goods. Additional distribution costs are the costs of packaging, sorting, transportation and storage of goods. This type of distribution costs is close to production costs and, when included in the cost of goods, increases the latter. Additional costs are reimbursed after the sale of goods from the proceeds received. Net distribution costs - costs of trade (salaries of salespeople, etc.), marketing (study of consumer demand), advertising, costs of paying headquarters staff, etc. Net costs do not increase the cost of goods, but are reimbursed after sale from the profits created in the process of producing goods.
Speaking about the costs of production and circulation, K. Marx considered the process of formation of costs directly according to their main elements in the production process. He abstracted from the problem of price fluctuations around value. In addition, in the twentieth century there was a need to determine changes in costs depending on the quantity of products produced.
Modern cost concepts developed by Western economists largely take into account both of the above points. At the center of the classification of costs is the relationship between production volume and costs, the price of a given type of goods. Costs are divided into independent and dependent on the volume of products produced.
Fixed costs do not depend on the volume of production; they exist even at zero volume of production. These are the previous obligations of the enterprise (interest on loans, etc.), taxes, depreciation, security payments, rent, equipment maintenance costs with zero production volume, salaries of management personnel, etc. Variable costs depend on the quantity of products produced, and consist of the costs of raw materials, materials, wages to workers, etc. The sum of fixed and variable costs forms gross costs- the amount of cash costs for the production of a certain type of product. To measure the cost of producing a unit of output, the categories of average, average fixed and average variable costs are used. Average costs equal to the quotient of gross costs divided by the number of products produced. Average fixed costs determined by dividing fixed costs by the number of products produced. Average variable costs are formed by dividing variable costs by the number of products produced.
To achieve maximum profit, you need to determine the required production volume. The category of marginal costs serves as a tool for economic analysis. Marginal cost represent the additional costs of producing each additional unit of output compared to a given output. They are calculated by subtracting adjacent values of gross costs.
In the specific practice of using cost calculation to analyze the activities of enterprises in Russia and in Western countries, there are both similarities and differences. The category is widely used in Russia cost price, which represents the total costs of production and sales of products. Theoretically, the cost should include standard production costs, but in practice it includes excess consumption of raw materials, supplies, etc. The cost is determined on the basis of the addition of economic elements (costs of the same economic purpose) or by summing up the costing items that characterize the direct directions of certain expenses. Both in the CIS and in Western countries, to calculate costs, a classification of direct and indirect costs (expenses) is used. Direct costs- These are the costs directly associated with the creation of a unit of goods. Indirect costs necessary for the general implementation of the production process of this type of product at the enterprise. The general approach does not exclude differences in the specific classification of some articles.
In Western countries, the above-described division of costs (costs) into fixed and variable is used, with direct and part of the indirect costs classified as variable, and the remaining part of indirect costs (independent of production volume) classified as constant. Often the first of the above parts of indirect costs is allocated to a separate group - partially variable costs, since these costs do not change in value in direct proportion to changes in the volume of products produced. Dividing costs into direct and variable allows you to get the indicator - added value determined by subtracting variable costs from the total income (revenue) of the enterprise. The added value therefore consists of fixed costs and net profit. This indicator allows you to evaluate the overall efficiency of production and sales, regardless of variable costs directly dependent on the volume of production.
In the CIS, the division of costs into conditionally permanent And conditional variables, calculated by economic elements, is used when calculating savings from the influence of technical and economic factors. Such calculations are performed to determine the future planned cost of production based on the existing actual cost. This kind of calculation is not always appropriate, since it only allows one to determine the increase in costs in the event that conditionally fixed costs increased in direct proportion to the increase in the volume of production (a practically impossible situation).
In real production activities, it is necessary to take into account not only actual cash costs, but also opportunity cost. The latter arise due to the possibility of choosing between certain economic decisions. For example, the owner of an enterprise can spend the available money in different ways: use it to expand production or spend it on personal consumption, etc. Measuring opportunity costs is necessary not only for market relations, but also for objects that are not goods. In an unregulated goods market, opportunity costs will be equal to the currently established market price. If there are several different (usually close to each other) prices on the market, then the opportunity costs of selling the product at, naturally, the highest price offered to the seller by buyers will be equal to the highest of all remaining (except for the highest) prices offered.
Previously, the construction of hydroelectric power stations (HPPs) on rivers flowing through the plains was widespread in the USSR. It is possible to receive income from the production of electricity during the construction of a dam, the creation of a reservoir and the installation of a hydroelectric power station. If this construction is abandoned, it is possible, with the help of the freed-up monetary and material resources, to receive income from conducting intensive methods of coastal agriculture, fishing, forestry and other economic activities on lands that can be turned into the bottom of a hydroelectric power station reservoir. The total economic costs of obtaining electricity will be equal to the sum of the costs of constructing a hydroelectric power station and the valuation of the possible volume of production from intensive economic activity on flooded lands (opportunity costs). The total economic costs of any kind of economic activity must include, in addition to the usual monetary and material, also alternative costs, covering the valuation of the best possible alternative decisions on the use of available resources (labor, money, material, etc.).
The concept of opportunity costs is also necessary in direct production activities. Let's assume that a machine-building enterprise manufactures one of the parts for its assembly production at a cost of 5,100 rubles, with variable costs equal to 3,900 rubles, and fixed costs - 1,200 rubles. What decision will the enterprise make if another enterprise offers the first this part for 4,600 rubles? Despite the apparent attractiveness and profitability of the proposal received, solving the problem is difficult. To make a decision you must:
1. compare not the final values (5100 and 4600 rubles), but 3900 and 4600 rubles, since the fixed costs of the first enterprise do not depend on external purchases or in-house production of this part;
2. determine how profitable it would be to use the released production equipment of the first plant to produce other parts if the part in question was purchased externally.
In the first comparison, if in-house production is preferred, the opportunity costs of using the enterprise's funds to purchase a unit of this part (compared to in-house production) are equal to 4,600 rubles. The possibility of a second comparison is not taken into account here. In the case of the second comparison, the decision to transfer production equipment to the production of other parts will be profitable only if the increase in profit covers the total losses from purchasing this part externally - 700 rubles (4600-3900), multiplied by the number previously produced on our own equipment details. With real profitability, high profitability of transferring equipment to the production of other parts, their total economic costs will consist of ordinary production costs (fixed and variable) and “total losses” (opportunity costs). In a particular case, with an equal share of profit in the price and the same number of parts produced, “real profitability” is achieved if the variable costs of “other parts” are less than 3,200 rubles (3,900-700 rubles).
The previously discussed category of “marginal costs” is of fundamental importance for determining the volume of production that brings maximum profit and studying the efficiency of resource allocation. As long as, under conditions of perfect competition (many small producers producing identical goods, and each of them does not affect the market price), the income from the last additional unit of goods sold exceeds the marginal cost of this unit of goods, the profit of the enterprise will increase. For any enterprise, the most profitable will be the production and sale of such volume of products when there is equality of additional income and marginal costs. The last good produced and sold will equalize marginal cost and unit price, since selling more output will not bring additional profit. The enterprise will strive to maximize profits when producing goods whose marginal costs are below the market price, and will stop producing goods whose marginal costs exceed the market price.
Every society strives for an efficient economy that allows for the optimal distribution of available resources for the production of a wide range of goods (services) that maximally satisfy needs in terms of quality and quantity. V. Pareto made a significant contribution to the study of this problem. According to the Pareto concept, under perfect competition, for the profitability of one entrepreneur to increase, the affairs of another must deteriorate.
The correspondence between marginal utility and marginal cost in each industry is necessary for increased efficiency and social welfare. Efficiency in resource allocation is achieved by equalizing marginal costs and the market price (which is proportional to marginal utility) as a result of competition.
In general, the concept of allocative efficiency allows any society to move towards increasing output. If marginal costs and market prices are equal, products will be produced at minimum gross costs.
COST REDUCTION METHODS.
Undoubtedly, every manufacturer should strive to reduce production costs and reduce production costs. With a stable price for products sold and other equal conditions, cost reduction leads to an increase in profit per unit of product.
As is known, the production of higher quality products requires a higher level of production costs. However, in the late 70s - early 80s, this postulate was practically refuted by Japanese engineering companies. It turned out that enterprises producing high-quality products have increased labor productivity and lower production costs. Advanced enterprises in the automotive and electronics industries in Japan are 2-2.5 times higher in labor productivity than enterprises in the same industries in the United States. Japanese firms typically spend $1,600 less than American firms to produce a subcompact passenger car. A study of the specific costs of Japanese automakers showed that this difference arises primarily due to the organization of production using the just-in-time method.
The just-in-time method is the core of the production management system of the Japanese automobile company Toyota. The main goal of this system is to reduce costs. The system promotes increased efficiency of production activities and increases capital turnover (the ratio of sales volume to the total cost of fixed capital). The new management system develops the best features of the previous systems of scientific management by F. Taylor and the conveyor system of G. Ford.
To reduce costs, it is necessary to adapt the system to daily fluctuations in demand by continuously adjusting the range and volume of products, providing high-quality components, and increasing the interest and activity of workers. The main principles of the “just in time” system are autonomy and flexible use of personnel. This method requires the production of the required type of product at the required time and in the required quantity. Autonomy means independent control over the marriage. It is not possible to receive defective products for further processing. Flexible use of personnel refers to fluctuations in the number of workers due to changes in demand for products that occur from time to time, as well as encouraging creativity and the implementation of ideas.
The use of advanced Japanese production management methods allows us to achieve high efficiency. What are the main advantages of the Toyota system? When working using the “just in time” method, at the site preceding a given production process, the exact quantity of parts ordered by this (subsequent) site is produced and delivered within the specific time frame specified by it. Here, the subsequent stage of production, as it were, pulls out the number of parts it needs for a certain time period from the previous stage. With the usual production scheduling in our and other countries, the previous section, as it were, “pushes” the previously planned and produced volume of parts to the subsequent section of the production process.
In the Toyota system, a production site sends a card called a “kanban” to its predecessor. Two types of cards indicate either the number of parts that need to be picked up at the previous section, or the number of parts that need to be produced at the previous section. Three concepts are often confused: the Toyota system, the just-in-time system and the kanban system. The Toyota system is a method of organizing product production. The “just in time” system is the principle of producing the required number of parts at the required time. The “kanban” system is a means of implementing the “just in time” system, an information system for quickly regulating the volume of production at different stages of the production process. “Kanban” is one of the conditions for the functioning of a “just in time” system.
The Toyota system provides for the possibility of changing the volume of daily production, and accordingly less or more (due to overtime) components will be produced that day. The method of “fine-tuning” the production process is also used, leveling the volume of production by constantly adapting to demand using a gradual fluctuation in the frequency of produced batches of products with a constant batch size.
With continued use of the same die, average production costs are reduced. However, in conditions of a wide range of products and a minimum number of workpieces, it is necessary to reduce replacement time and costs for readjusting the die. In order to automate and automate product quality control, machines are equipped with automatic stopping devices in case of breakdown, workers are given the right to stop the production line if a deviation or defect is detected. At Toyota factories, almost all workers participate in “quality circles.” There, workers have the opportunity to propose various ways to improve production and improve product quality. Material offers from workers are encouraged.
Overall, the Toyota system aims to increase profits by reducing the costs of excess labor and inventory. Both production and distribution costs are being reduced, thanks to constant attention to fluctuations in market demand.
LITERATURE:
Japanese industrial system. Ch. Macmillan, Progress, 1988.
Economics. K. McConnell, S. Brew, Moscow, 1992.
Economics and business. Moscow, 1993.
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Any business involves costs. If they are not there, then there is no product supplied to the market. To produce something, you need to spend money on something. Of course, the lower the costs, the more profitable the business.
However, following this simple rule requires the entrepreneur to take into account a large number of nuances that reflect the variety of factors influencing the success of the company. What are the most noteworthy aspects that reveal the nature and types of production costs? What does business efficiency depend on?
A little theory
Production costs, according to a common interpretation among Russian economists, are the costs of an enterprise associated with the acquisition of so-called “factors of production” (resources without which a product cannot be produced). The lower they are, the more economically profitable the business is.
Production costs are measured, as a rule, in relation to the total costs of the enterprise. In particular, a separate class of expenses may include those associated with the sale of manufactured products. However, everything depends on the methodology used in classifying costs. What are the options here? Among the most common in the Russian marketing school are two: the “accounting” type methodology, and the one called “economic”.
According to the first approach, production costs are the total set of all actual expenses associated with the business (purchase of raw materials, rental of premises, payment of utilities, personnel compensation, etc.). The “economic” methodology also involves the inclusion of those costs, the value of which is directly related to the company’s lost profit.
In accordance with popular theories adhered to by Russian marketers, production costs are divided into fixed and variable. Those that belong to the first type, as a rule, do not change (if we talk about short-term time periods) depending on the growth or reduction in the rate of production of goods.
Fixed costs
Fixed production costs are, most often, such expense items as rent of premises, remuneration of administrative personnel (managers, executives), obligations to pay certain types of contributions to social funds. If they are presented in the form of a graph, it will be a curve that is directly dependent on the volume of production.
As a rule, enterprise economists calculate average production costs from those that are considered constant. They are calculated based on the volume of costs per unit of manufactured goods. Typically, as production volumes increase, the average cost “schedule” decreases. That is, as a rule, the greater the productivity of the factory, the cheaper the unit product.
Variable costs
The enterprise's production costs related to variables, in turn, are very susceptible to changes in the volume of output. These include the costs of purchasing raw materials, paying for electricity, and compensating staff at the specialist level. This is understandable: more material is required, energy is wasted, new personnel are needed. A graph showing the dynamics of variable costs is usually not constant. If a company is just starting to produce something, then these costs usually grow more rapidly in comparison with the rate of increase in production.
But as soon as the factory reaches a sufficiently intensive turnover, then variable costs, as a rule, do not grow so actively. As with fixed costs, an average is often calculated for the second type of cost - again, in relation to unit output. The combination of fixed and variable costs is the total cost of production. Usually they are simply added together mathematically when analyzing a company's economic performance.
Costs and depreciation
Phenomena such as depreciation and the closely related term “wear and tear” are directly related to production costs. By what mechanisms?
First, let's define what wear is. This, according to the interpretation widespread among Russian economists, is a decrease in the value of production resources. Wear and tear can be physical (when, for example, a machine or other equipment simply breaks down or cannot withstand the previous rate of production of goods), or moral (if the means of production used by the enterprise, say, are much inferior in efficiency to those used in competing factories ).
A number of modern economists agree that obsolescence is a constant cost of production. Physical - variables. The costs associated with maintaining production volumes of goods subject to wear and tear of equipment form the same depreciation charges.
As a rule, this is associated with the purchase of new equipment or investments in the repair of current equipment. Sometimes - with a change in technological processes (for example, if a machine producing spokes for wheels breaks down at a bicycle factory, their production may be outsourced temporarily or on an indefinite basis, which, as a rule, increases the cost of producing finished products).
Thus, timely modernization and purchase of high-quality equipment is a factor that significantly influences the reduction of production costs. Newer and more modern equipment in many cases involves lower depreciation costs. Sometimes the costs associated with equipment wear and tear are also influenced by the qualifications of the personnel.
As a rule, more experienced craftsmen handle equipment more carefully than beginners, and therefore it may make sense to spend money on inviting expensive, highly qualified specialists (or invest in training young ones). These costs may be lower than investments in depreciation of equipment subject to intensive use by inexperienced beginners.
Production costs include the expenses necessary to create a product or service. For any enterprise, production costs and their types can act as payment for acquired production factors. When costs are examined from the point of view of an individual enterprise, we can talk about private costs. If costs are analyzed from the point of view of the entire society, then the need arises to take into account total costs.
Social costs are characterized by external effects of a positive and negative nature. Private social costs can coincide only when there are no externalities or their total effect is zero. Thus, we can say that social costs are equal to the sum of private costs and externalities.
Production costs and their types
Fixed costs include costs determined by the enterprise within one production cycle. The amount and list of fixed costs is determined by each enterprise independently; these costs will be present in all product release cycles.
Production costs and their types include variable costs that can be transferred to the finished product in full. By adding up fixed and variable costs, we get the total costs incurred by the company during each stage of production.
There is also a classification of costs into accounting and economic costs. Accounting costs include the cost of resources used by the enterprise in the actual prices of their acquisition. Accounting costs are explicit costs.
Production costs and their types include economic costs, which represent the cost of other benefits that can be obtained with the most profitable option for the use of resources. Economic costs are opportunity costs that include the sum of explicit and implicit costs. Accounting and economic costs may or may not coincide with each other.
Explicit and implicit costs
Production costs and their types imply a classification into explicit and implicit costs. Explicit costs can be determined through the amount of company expenses for paying for external resources that are not owned. These may include materials, fuel, labor and raw materials.
Implicit costs can be determined by the cost of internal resources that are owned by this enterprise. The main example of implicit costs is represented by the wages that an entrepreneur might receive if he were employed.
Explicit costs are opportunity costs that can take the form of cash payments to suppliers of production factors and intermediate goods. Explicit costs include payment for transport, rent, wages to employees, cash costs for the purchase of equipment, buildings and structures, payment for services of banks and insurance companies.
Other types of costs
Production costs and their types can be refundable or non-refundable. In the broad sense of the word, sunk costs are expenses that a company cannot recover even if it ceases operations. This may include preparing advertising and obtaining a license, or the costs of registering an enterprise.
In a narrow sense, sunk costs represent the costs of those types of resources that have no alternative use. If the equipment cannot be used alternatively, then we can say that its opportunity costs are zero.
There is also a classification of costs into fixed and variable. If we consider the short-term period, then some of the resources will remain unchanged, some will change in order to increase or decrease total output.
Fixed and variable costs
Dividing costs into fixed and variable costs only makes sense for the short term. If we consider long-term periods, then such a division will lose meaning, since all costs change, that is, they are variable.
We can say that fixed costs do not depend on how many products the company produces in the short term. This could be depreciation, interest payments on bonds, rental payments, insurance payments, and salaries of management personnel. Variable costs depend on the volume of output, and includes costs for variable production factors (transport costs, utility bills, payment for raw materials, etc.).
Firm(enterprise) is an economic unit that realizes its own interests through the production and sale of goods and services through the systematic combination of factors of production.
All firms can be classified according to two main criteria: the form of ownership of capital and the degree of concentration of capital. In other words: who owns the company and what is its size. Based on these two criteria, various organizational and economic forms of entrepreneurial activity are distinguished. This includes public and private (sole proprietorships, partnerships, joint stock) enterprises. According to the degree of concentration of production, small (up to 100 people), medium (up to 500 people) and large (more than 500 people) enterprises are distinguished.
Determining the amount and structure of an enterprise's (firm's) costs for production, which would ensure the enterprise a stable (equilibrium) position and prosperity in the market, is the most important task of economic activity at the micro level.
Production costs - These are expenses, monetary expenditures that must be made to create a product. For an enterprise (firm), they act as payment for acquired factors of production.
The majority of production costs comes from the use of production resources. If the latter are used in one place, they cannot be used in another, since they have such properties as rarity and limitation. For example, money spent on buying a blast furnace to produce pig iron cannot simultaneously be spent on producing ice cream. As a result, by using a resource in a certain way, we lose the opportunity to use this resource in some other way.
Due to this circumstance, any decision to produce something necessitates the refusal to use the same resources for the production of some other types of products. Thus, costs represent opportunity costs.
Opportunity Cost- these are the costs of producing a product, assessed in terms of the lost opportunity to use the same resources for other purposes.
From an economic point of view, opportunity costs can be divided into two groups: “explicit” and “implicit”.
Explicit costs- These are opportunity costs that take the form of cash payments to suppliers of factors of production and intermediate goods.
Explicit costs include: workers' wages (cash payments to workers as suppliers of the production factor - labor); cash costs for the purchase or payment for the rental of machines, machinery, equipment, buildings, structures (cash payments to capital suppliers); payment of transportation costs; utility bills (electricity, gas, water); payment for services of banks and insurance companies; payment to suppliers of material resources (raw materials, semi-finished products, components).
Implicit costs - these are the opportunity costs of using resources owned by the company itself, i.e. unpaid expenses.
Implicit costs can be represented as:
1. Cash payments that a company could receive if it used its resources more profitably. This can also include lost profits (“lost opportunity costs”); the wages that an entrepreneur could earn by working somewhere else; interest on capital invested in securities; rent payments for land.
2. Normal profit as the minimum remuneration to an entrepreneur that keeps him in the chosen industry.
For example, an entrepreneur engaged in the production of fountain pens considers it sufficient for himself to receive a normal profit of 15% of the invested capital. And if the production of fountain pens gives the entrepreneur less than normal profit, then he will move his capital to industries that give at least normal profit.
3. For the owner of capital, implicit costs are the profit that he could have received by investing his capital not in this, but in some other business (enterprise). For a peasant who owns land, such implicit costs will be the rent that he could receive by renting out his land. For an entrepreneur (including a person engaged in ordinary labor activities), the implicit costs will be the wages that he could receive for the same time, working for hire at any company or enterprise.
Thus, Western economic theory includes the income of the entrepreneur in production costs. Moreover, such income is considered as a payment for risk, which rewards the entrepreneur and encourages him to keep his financial assets within the boundaries of this enterprise and not divert them for other purposes.
Production costs, including normal or average profit, are economic costs.
Economic or opportunity costs in modern theory are considered to be the costs of a company incurred in the conditions of making the best economic decision on the use of resources. This is the ideal to which a company should strive. Of course, the real picture of the formation of total (gross) costs is somewhat different, since any ideal is difficult to achieve.
It must be said that economic costs are not equivalent to those with which accounting operates. IN accounting costs The entrepreneur's profit is not included at all.
Production costs, which are used by economic theory, are distinguished from accounting by the assessment of internal costs. The latter are associated with costs that are incurred through the use of own products in the production process. For example, part of the harvested crop is used to sow the company's land. The company uses such grain for internal needs and does not pay for it.
In accounting, internal costs are accounted for at cost. But from the standpoint of setting the price of a released product, costs of this kind should be assessed at the market price of that resource.
Internal costs - These are associated with the use of the company’s own products, which turn into a resource for the company’s further production.
External costs - This is the expenditure of money that is made to acquire resources that are the property of those who are not the owners of the company.
Production costs that are incurred in the production of a product can be classified not only depending on what resources are used, be it the resources of the company or the resources that had to be paid for. Another classification of costs is possible.
Fixed, variable and total costs
The costs that a firm incurs in producing a given volume of output depend on the possibility of changing the quantity of all employed resources.
Fixed costs(FC, fixed costs)- these are costs that do not depend in the short term on how much the company produces. They represent the costs of its constant factors of production.
Fixed costs are associated with the very existence of the firm's production equipment and must therefore be paid, even if the firm does not produce anything. A firm can avoid the costs associated with its fixed factors of production only by completely ceasing its activities.
Variable costs(US, variable costs)- These are costs that depend on the volume of output of the company. They represent the costs of the firm's variable factors of production.
These include costs of raw materials, fuel, energy, transportation services, etc. The majority of variable costs typically come from labor and materials. Since the costs of variable factors increase as output increases, variable costs also increase with output.
General (gross) costs for the quantity of goods produced - these are all the costs at a given point in time necessary for the production of a particular product.
In order to more clearly determine the possible production volumes at which the company guarantees itself against excessive growth of production costs, the dynamics of average costs is examined.
There are average constants (AFC). average variables (AVC) PI average general (PBX) costs.
Average fixed costs (AFS) represent the ratio of fixed costs (FC) to output volume:
AFC = FC/Q.
Average variable costs (AVQ represent the ratio of variable costs (VC) to output volume:
AVC=VC/Q.
Average total costs (PBX) represent the ratio of total costs (TC)
to output volume:
ATS= TC/Q =AVC + AFC,
because TS= VC + FC.
Average costs are used when deciding whether to produce a given product at all. In particular, if the price, which is the average income per unit of output, is less than AVC, then the firm will reduce its losses by suspending its activities in the short term. If the price is lower ATS, then the firm receives negative economics; profits and should consider permanent closure. Graphically this situation can be depicted as follows.
If average costs are below the market price, then the firm can operate profitably.
To understand whether producing an additional unit of output is profitable, it is necessary to compare the resulting change in income with the marginal cost of production.
Marginal cost(MS, marginal costs) - These are the costs associated with producing an additional unit of output.
In other words, marginal cost is the increase TS, the lengths a firm must go to produce one more unit of output:
MS= Changes in TS/ Changes in Q (MC = TC/Q).
The concept of marginal cost is strategic because it identifies costs that a firm can directly control.
The equilibrium point of the firm and maximum profit is reached when marginal revenue and marginal cost are equal.
When a firm has reached this ratio, it will no longer increase production, output will become stable, hence the name - equilibrium of the firm.
