Cost analysis is carried out with the obligatory division of the period into short-term and long-term. The essence of the difference between them lies in the increase in production capacity. In a short time it is impossible to technically re-equip the enterprise, the reconstruction is carried out for a rather long time. By calculating production costs in the long run and establishing their dynamics, the economist will be able to determine the strategic ways of the firm to maximize profit and minimize costs. But first you need to decide on such an economic concept as production costs in the short run.
Production costs of short periods are characterized by the division into fixed and variable. The former do not depend on the size of production, and the enterprise carries them even when work stops. Usually this is rent, depreciation, planned capital repair costs, A&M salary, etc. Variables change due to changes in production volumes. This is the salary of shop personnel, the cost of material and energy resources, the transportation of finished goods.
Differences between cost elements are important to any business because variable costs can be controlled. Permanent ones are not under the control of the company's administration - they are mandatory in any situation. Combining fixed and variable costs creates a gross or total.
The dynamics of production costs in the short term can be traced in a graph that clearly demonstrates the growth of production costs due to variable costs with an increase in output:
For a detailed analysis of costs, in addition to the average total costs, the average fixed and average variable costs are used, calculating them as the ratio of the size of the corresponding costs to the output. This is how production costs are determined in the short run. Let's briefly explain what the short-run cost analysis shows:
The average total cost is usually needed by the economist to analyze the comparison with the price of the manufactured product. This makes it possible to calculate the amount of profit and determine the ways of the company's development in the near future.
Production costs in the short and long run are homogeneous in composition, but the costs in a long time differ in their specificity, since they are interconnected with the scale of production, which can radically change. Here, the main feature of costs is that they are all variable in nature, since all resources can change. For example, a company can increase or decrease capacity, move to another industry, etc. Therefore, the firm's production costs in the long run are not delineated into average constant and average variables, and analysts work with long-term average total costs, which are essentially the average variable costs.
Often, economists resort to dividing the long-term period into many short ones and analyze the dynamics of production costs in the long run by combining data from the analysis of the costs of short-term periods. This method enables the economist to fix the lowest values of unit costs for any volume of output and to determine the necessary factors of production that can be changed. Graphically it looks like this:
The development of production affects costs in different ways. The cost savings characteristic of capacity growth and the increasing return on them due to the outstripping growth in production costs create a positive effect, since the average long-term costs per unit of output in such conditions are noticeably reduced.
However, the positive effect of the growing scale of production is not unlimited. Over time, expansion of a company can produce negative results if higher output drives higher costs. This happens, for example, with a decrease in consumer demand and a decrease in sales opportunities. The negative effect is characterized by a decrease in the efficiency of the firm and an increase in average costs, therefore, when planning the scale of production, the company should limit the limits of its expansion. Constant returns to scale arises when costs and output are the same in terms of growth.
We explained that in economics, production costs in the long run are briefly, but , Having understood their structure and dynamics, it is easy to explain the importance of these indicators in determining the company's strategy for optimizing production and making a profit.
A short-term period is a period of time too short for a change in production capacities, but sufficient for a change in the intensity of the use of these capacities. Production capacities remain unchanged in the short term, and the volume of output can change by changing the amount of labor, raw materials, and other resources used at these capacities. The cost of production of any product depends not only on the prices of resources, but also on technologies - on the amount of resources that is needed for production. We'll look at how the output will change as more and more variable resources are introduced.
Production costs in the short run are divided into fixed, variable, general, average and marginal. Fixed costs (FC) - costs that do not depend on the volume of production. They will always be the case, even if the firm does not produce anything. These include: rent, deductions for depreciation of buildings and equipment, insurance premiums, expenses for major repairs, payment of obligations on bonds, as well as salaries of senior management personnel, etc. Fixed costs remain unchanged at all levels of production, including zero. Graphically, they can be represented as a straight line parallel to the abscissa axis (see Fig. 1). It is indicated by the FC line. Variables (VC) - costs that depend on the volume of production. These include the cost of wages, raw materials, fuel, electricity, transportation services and similar resources. In contrast to fixed variable costs, they change in direct proportion to the volume of production.
They are plotted graphically as an upward curve (see Figure 1) denoted by the VC line. The variable cost curve shows that as the output of a product increases, the variable costs of production increase. The distinction between fixed and variable costs is essential for every businessman. The entrepreneur can manage variable costs, since their value changes over the short term as a result of changes in the volume of production. Fixed costs are outside the control of the firm's administration, since they are mandatory and must be paid regardless of the volume of production.
Rice. 1.
Total, or gross, costs (total cost, TC) - costs in general for a given volume of production. They are equal to the sum of fixed and variable costs: TC = FC + VC. If you superimpose the curves of fixed and variable costs, you get a new curve that reflects the total costs (see Figure 1). It is indicated by the TC line. Average total (average total cost, ATC, sometimes called AC) is the cost per unit of production, i.e. total costs (TC) divided by the amount of production (Q): ATC = TC / Q. Average total costs are commonly used for comparison with prices, which are always quoted per unit of output. This comparison makes it possible to determine the amount of profit, which allows you to determine the tactics and strategy of the company in the near future and in the future. Graphically, the curve of average total (gross) costs is depicted by the ATC curve (see Fig. 2). The average cost curve is U-shaped. This suggests that average costs may be equal to the market price, or may deviate from it. A firm is profitable or profitable if the market price is higher than average costs.
Rice. 2.
In economic analysis, in addition to average total costs, concepts such as average fixed and average variable costs are used. This is similar to the average total cost, fixed and variable costs per unit of output. They are calculated as follows: average fixed costs (AFC) are equal to the ratio of fixed costs (FC) to output (Q): AFC = FC / Q. Average variables (AVC), by analogy, are equal to the ratio of variable costs (VC) to output (CZ):
Average total costs - the sum of average fixed and variable costs, i.e.:
ATC = AFC + AVC, or ATC = (FC + VC) / Q.
The value of the average fixed costs decreases continuously as the volume of production increases, since a fixed amount of costs is distributed over more and more units of production. Average variable costs change in accordance with the law of diminishing returns. An important factor in determining the strategy of a firm in economic analysis is given to marginal costs. Marginal, or marginal, costs (marginal cost, MC) - costs associated with the production of an additional unit of production. MS can be determined for each additional unit of production by dividing the change in the increase in the sum of total costs by the value of the increase in output, i.e.:
MS = DTS / DQ.
Marginal costs (MC) are equal to the increase in variable costs (DVC) (raw materials, labor), if it is assumed that fixed costs (FC) are unchanged. Therefore, marginal cost is a function of variable costs. In this case:
MS = DVC / DQ.
Thus, marginal costs (sometimes called incremental costs) represent the cost increment resulting from the production of one additional unit of output. Marginal cost shows how much it will cost a firm to increase its output by one unit. Graphically, the marginal cost curve is an ascending MC line, intersecting at point B with the average total ATC cost curve and point B with the average variable cost AVC curve (see Figure 3). Comparison of average variables and marginal production costs is important information for managing a firm, determining the optimal size of production, within which the firm receives a stable income.
Rice. 3.
Fig. 3 shows that the curve of marginal costs (MC) depends on the value of average variable costs (AVC) and gross average costs (ATS). At the same time, it does not depend on the average fixed cost (AFC), because the fixed cost FC exists regardless of whether additional production is produced or not. Variable and gross costs rise with output. The rate at which these costs increase depends on the nature of the production process and, in particular, on the extent to which production is subject to the law of diminishing returns with respect to variable factors. If labor is the only variable, what happens when output increases? To produce more, a firm must hire more workers. Then, if the marginal product of labor quickly decreases as labor costs increase (due to the law of diminishing returns), more and more costs are needed to accelerate production. As a result, variable and gross costs rise rapidly along with an increase in output. On the other hand, if the marginal product of labor decreases slightly with an increase in the number of labor resources used, costs will not increase so quickly with an increase in output. Marginal and average costs are important concepts. As we will see in the next chapter, they have a decisive effect on a firm's choice of output. Knowledge of short-term costs is especially important for firms operating in the face of marked fluctuations in demand. If a firm is currently producing output at a rate at which marginal costs rise sharply, uncertainty about future demand increases may force the firm to make changes in the manufacturing process, and possibly induce additional costs today to avoid higher costs tomorrow.
Economic costs. Internal and external costs. Economic profit.
The most important factor determining the ability and desire of a firm to put a product on the market are production costs.
Use of certain resources for the production of a commodity means the impossibility of producing another commodity. The costs in the economy are directly related to the rejection of the possibility of producing alternative goods and services.
Imputed (economic) costs any resource is equal to its value at the best possible use case.
Cash expenses that the firm carries out in favor of some external organizations are called explicit costs. Expenses for the consumption of own, internal resources are implicit costs. For example, for the owner of a small shop where he works himself, there are explicit costs of purchasing goods, but there are no explicit costs of renting premises and wages. The implicit costs in this case represent the income that the owner of this store could receive if he rented out this premises and received a salary somewhere.
Minimum Fee for a resource such as the entrepreneurial ability required to keep a store owner in his store is called normal economic profit, which is also an element of implicit costs.
So, all payments, external and internal, incl. the normal profit required to attract and retain resources within the business.
Economic profit is different from accounting profit.
Accounting profit = total revenue - explicit cost
Economic profit = total revenue - economic cost
Economic costs = explicit costs + implicit costs (including normal profit)
Economic profit is income earned in excess of normal profit.
Somewhat conventionally, all resources used in production can be divided into two large groups: resources, the value of which can be changed very quickly (for example, the cost of raw materials, materials, energy, labor, etc.) and resources, change the volume of use which is possible only for a sufficiently long period of time (construction of a new production facility).
Based on these circumstances, cost analysis is usually carried out in two time intervals: in the short term (when the amount of a certain resource remains constant, but the volume of production can be changed due to the use of more or less resources such as labor, raw materials, materials, etc.) and in the long term period (when you can change the amount of any resource used in production).
The difference between the short-term and long-term periods exactly correspond to the difference between fixed and variable factors of production.
Variable factors of production- factors of production, the number of which can be changed within a short-term period (for example, the number of employees).
Constant factors of production- factors, the costs of which are specified and cannot be changed within the short-term period (for example, production capacity). Thus, in the short run, the entrepreneur uses both fixed and variable factors of production. In the long run, all production factors are variable.
. fixed costs(TFC) the value of which does not depend on the volume of products ( depreciation deductions, interest on a bank loan, rent, maintenance of the administrative apparatus, etc.). We are talking about the cost of resources related to constant factors of production. The magnitude of these costs is not related to the volume of production. Fixed costs exist even when the production activity at the enterprise is suspended, and the volume of production is zero. An enterprise can avoid these costs only by completely ceasing its activities;
. variable costs(TVC), the value of which changes depending on the change in the volume of production (costs of raw materials, materials, fuel, energy, wages of workers, etc.). We are talking about the cost of resources related to variable factors of production. With the expansion of production, variable costs will increase, since the company will need more raw materials, materials, workers, etc. while fixed costs remain unchanged.
Difference between fixed and variable costs are essential for every businessman: he can manage variable costs, fixed costs must be paid regardless of the volume of production, even if production is suspended.
In addition to fixed and variable costs in the short-term period, one more type of costs is distinguished - gross (cumulative, total, total). Gross costs (TS) - the sum of fixed and variable costs, calculated for each given volume of production: TC = TFC + TVC.
Gross Costs (TC) - this is the sum of fixed and variable costs.
Since the TFCs are equal some constant, the dynamics of gross costs will depend on the behavior of TVC, that is, it will be determined by the action of the law of diminishing marginal productivity (therefore, the graph of the function TVC and TFC is not a straight line).
The law of diminishing returns states that, starting from a certain moment, the successive addition of units of a variable resource to an unchanged, fixed resource gives a decreasing additional product per each subsequent unit of a variable resource.
Picture 1.
In addition to gross costs the entrepreneur is interested in the cost per unit of production, since it is they that he will compare with the price of the product in order to get an idea of the profitability of the firm. The cost per unit of production is called average. This group of costs includes:
Average Fixed Cost (AFC) are determined by dividing the total fixed cost (TFC) by the quantity of products produced. AFCs fall as production increases
AFC = TFC / Q
Average Variable Cost (AVC) are determined by dividing the total variable cost (TVC) by the quantity of products produced. AVCs first fall, reaching their minimum, and then start to rise, because TVCs obey the law of diminishing returns.
AVC = TVC / Q
Average Total Cost (ATC) calculated by dividing the sum of total costs by the quantity of products or as the sum of AFC and AVC.
ATC = TC / Q = AVC + AFC
Average fixed costs graph presented hyperbo-loy(picture below). The average variable cost graph is an irregular parabola with branches up. Two line segments can be selected on this curve. On the first, AVC decreases, on the second, it increases. Such dynamics of average variable costs is associated with the action of the law of diminishing marginal returns. As long as the return on each subsequent unit of the variable resource increases (the area of increasing marginal return in the figure below), the average variable costs fall.
As volumes increase production of an additional product begins to decline - the marginal return of each subsequent unit of a variable resource falls - therefore, for a further increase in production, more and more variable resources are required, and the average variable costs of AVC increase. The graph of average total costs is obtained by vertically summing two curves - AFC and AVC. In this regard, the dynamics of automatic telephone exchange will be associated with the dynamics of average fixed and average variable costs. While both those and others are decreasing, ATCs fall, but when, as the volume of production increases, the growth of variable costs begins to outstrip the fall in constant ones, ATCs begin to increase.
Picture 2
Marginal Cost (MC) additional costs associated with the production of one more unit of production are called.
MC = TC change / Q change
Should be considered that the marginal costs largely depend on variable costs, therefore, similarly to the situation with variable costs, as well as with average variable and average total costs, two segments are distinguished on the MS graph: a segment with negative dynamics and a segment with positive dynamics, which is also explained by the existence of the law of loss. increasing marginal return. Another feature of the marginal cost graph is that it intersects the average variable and average total cost graphs at their lowest points (A and B).
In the process of producing goods and services, living and past labor is expended. At the same time, each firm seeks to obtain the greatest possible profit from its activities. To do this, each company has two ways: try to sell its goods at the highest possible price or try to reduce their production costs, i.e. production costs.
Depending on the time spent on changing the amount of resources used in production, there are short-term and long-term periods in the activities of the company.
Short-term is the time interval during which it is impossible to change the size of the manufacturing enterprise owned by the firm, i.e. the amount of fixed costs incurred by this firm. Over a short-term time interval, changes in the volumes of output can result solely from changes in the volumes of variable costs. It can influence the course and effectiveness of production only by changing the intensity of the use of its capacities.
During this period, the company can quickly change its variable factors - the amount of labor, raw materials, auxiliary materials, fuel.
In the short term, the number of some production factors remains unchanged, the number of others changes. Costs in this period are divided into fixed and variable costs.
This is due to the fact that the provision of fixed costs determine fixed costs.
Fixed costs... Fixed costs get their name due to their nature of invariability and independence from changes in production.
However, they belong to the category of recurrent costs, since their burden is on the firm on a daily basis if it continues to rent or own the production facilities it needs to continue production activities. In the event that these current costs take the form of periodic payments, they refer to explicit monetary fixed costs. If they reflect the opportunity costs associated with owning certain productive capacities acquired by the firm, they are implicit costs. In the graph, fixed costs are depicted by a horizontal line parallel to the abscissa axis (Fig. 1).
Rice. 1. Fixed costs
Fixed costs include: 1) the cost of remuneration of management personnel; 2) rental payments; 3) insurance premiums; 4) deductions for depreciation of buildings and equipment.
Variable costs
In addition to fixed costs, firms also incur variable costs (Fig. 2.). Variable costs can change rapidly within an enterprise of a given size as output changes. Raw materials, energy, hourly wages are examples of variable costs for most firms. It depends on the specific situation which costs are fixed and which are variable.
Fig 2. Variable costs
A short-term period is a period of time that is too short for an enterprise to be able to change its production capacity, but long enough to change the intensity of the use of these fixed capacities. In the short term, the firm is able to change the volume of production, involving in this process additional quantities of variable resources (the use of more or less human labor, raw materials and other resources) while the production capacity remains unchanged (fixed). But how does output change as more and more variable resources are added to the firm's permanent resources?
In its most general form, the answer to this question is given by the law of diminishing returns, which is also called the law of diminishing marginal product, or the law of changing proportions. This law states that when a variable resource (for example, labor) is sequentially connected to a constant (fixed) resource of a firm (for example, capital or land), the additional, or marginal, product attributable to each subsequent unit of a variable resource, starting from a certain moment, decreases.
Rice. 1. 6a and 1.6b illustrate the law of diminishing returns and help to gain a deeper understanding of the ratios of total, marginal, and average products.
As an additional variable resource (labor) joins the constant volume of other resources (land or capital), the resulting aggregate product first increases at a decreasing rate, then reaches its maximum and begins to decrease (Fig. 1.6a).
The marginal product (Fig. 1.6b) reflects the changes in the aggregate product associated with the investment of each additional unit of labor. The marginal product is an indicator of the change in the total product associated with the addition of each new worker. Therefore, the three phases through which the total product passes also affect the dynamics of the marginal product. When the total product grows at an accelerated rate, the marginal product inevitably increases. At this stage, additional workers contribute more and more to the total output. Likewise, when the total product grows, but at a slower pace, the marginal product is positive but shrinks. Each worker contributes less to the total output than his predecessor. When the total product reaches its maximum value, the marginal product becomes zero. And when the total product begins to decline, the marginal product becomes negative.
Figure 1.6 Curves of total, marginal and average products
The dynamics of the average product reflects the same general relationship "growth - maximum - decrease" between variable labor input and the volume of production, which is characteristic of the marginal product. However, attention should be paid to the ratio of marginal and average products: where the marginal product exceeds the average, the latter increases; and wherever the marginal product is less than the average, the latter decreases. It follows that the curve of the marginal product intersects the curve of the average product at the point where the latter reaches its maximum.
Fixed, variable and total costs
We already know that over a short period of time, some of the resources associated with the firm's production capacity remain unchanged. Other resources are modifiable. Hence it follows that within the short-term period, costs can be divided into fixed and variable.
In column (2) of table. 1.1 fixed costs of the firm are conventionally taken for 100 dollars. Fixed costs, by definition, exist for any volume of production, including zero. In the short term, fixed costs are unavoidable.
In column (3) of table. 1.1 we find that the total variable costs vary in direct proportion to the volume of production. However, the increment in the sum of variable costs associated with an increase in the volume of production per unit of output is not constant. At the beginning of the increase in production, variable costs increase, but their growth rate slows down over time. This continues up to the fourth unit of output, but then variable costs begin to increase at an increasing rate per each subsequent unit of output.
This behavior of variable costs is due to the law of diminishing returns. Due to the increase in the marginal product for the production of each subsequent unit of output, for some time, less and less increment in variable resources will be required. And since all units of variable resources have the same price, the total variable costs will increase at a diminishing rate. But as soon as the marginal product begins to decline in accordance with the law of diminishing returns, the production of each subsequent unit of production will require more and more additional variable resources. The sum of variable costs, therefore, will increase at an increasing rate.
Total costs are the sum of fixed and variable costs for any volume of production. Table 1.1 they are shown in column (4). With zero production, total costs are equal to the firm's fixed costs.
Variable costs are costs that an entrepreneur is able to manage, that is, change their value over a short period of time by changing the volume of production. Fixed costs, on the other hand, are not subject to ongoing control by the firm's management; such costs are inevitable in the short term and must be paid regardless of the volume of production.
Unit, or average, costs
Producers, of course, care about their overall costs, but they are just as worried about unit, or average, costs. In particular, it is the indicators of average costs that are more appropriate to use for comparison with the price of a product, which is always set per unit of production. Average fixed, average variable and average total costs are shown in columns (5), (6) and (7) of Table. 1. Let's see how the values of unit costs are calculated and how they change depending on changes in the volume of production.
1. Average fixed costs (AFC) of any volume of production is determined by dividing the total fixed costs by the corresponding amount of output:
Since total fixed costs are, by definition, independent of the volume of production, average fixed costs decrease as production increases. With an increase in production, the total fixed costs of, say, $ 100 are distributed over more and more units of the product produced. In fig. 1.7 the curve of average fixed costs decreases continuously as the volume of production rises.
2. Average variable costs (AVC) of any volume of production are determined by dividing the total variable costs by the corresponding amount of output:
Average variable costs initially decline until they reach their minimum, and then begin to rise. Graphically, this manifests itself in the concave arcuate shape of the average variable cost curve, which is shown in Fig. 1.7.
Since the total variable costs obey the law of diminishing returns, insofar as this should be reflected in the values of the average variable costs, which are calculated on their basis. In the incremental phase, each of the first four units of the product requires fewer and fewer additional variable resources to produce. As a result, variable costs per unit of product are reduced. In the production of the fifth unit, the average variable costs reach their minimum value and then begin to increase, since the decrease in returns generates the need for more and more variable resources for the production of each additional unit of the product.
The convex average product curve is an inverted concave arcuate average variable cost curve.
3. Average total costs (ATC) of any volume of production is calculated by dividing the total costs by the corresponding amount of products produced or by adding the average fixed and average variable costs of a given volume of production:
ATC = TC / Q = AFC + AVC (1.7)
The values of this indicator are given in column (7) of the table. 1.1. Graphically, the average total cost is determined by adding the curves of the average fixed and average variable costs vertically, as shown in Fig. 1.7. Thus, the interval between the curves of average total and average variable costs indicates the value of average fixed costs for any volume of production.
Marginal cost
From column (4) table. 1.1 shows that as a result of the production of the first unit of the product, total costs increase from 100 to 190 dollars. Therefore, the additional, or marginal, cost of production of this first unit is $ 90. (column 8) etc.
Marginal cost can also be calculated based on total variable costs (column 3), since total and total variable costs differ only by a fixed amount of fixed costs ($ 100). Therefore, the change in total cost is always equal to the change in the total variable cost for each additional unit of product.
Marginal cost is inherently more than all others amenable to direct and immediate control. Output decisions are usually based on margins, that is, decisions about whether a firm produces one unit more or one less product. Combined with the marginal revenue metric, the marginal cost metric allows a firm to determine the profitability of a given change in production scale. In fig. 1.8 depicts a marginal cost curve. It goes down steeply, reaches its minimum and then goes up quite steeply. This reflects the fact that variable costs, and therefore total costs, first increase at a decreasing rate and then at an increasing rate.
The marginal cost (MC) curve intersects the curves of average total (ATC) and average variable costs (AVC) at the points of the minimum value of each of them. This is explained by the fact that as long as the additional, or marginal, value added to the total (or variable) costs remains less than the average value of these costs, the average value of costs will necessarily decrease. Conversely, when the marginal value is added to the total (or variable) costs and exceeds their average value, then the average cost should increase.
The relationship between marginal product and marginal cost is easy to understand from Figure 1.9.
The marginal cost (MC) and average variable cost (AVC) curves are mirror images of the marginal product (MP) and average product (AP) curves, respectively. Assuming labor is the only variable cost element and the price of labor (wage rate) remains constant, marginal cost can be calculated by dividing the wage rate by the marginal product. Therefore, when the marginal product rises, the marginal cost falls; when the marginal product reaches a maximum, marginal costs take on a minimum value; and when the marginal product decreases, the marginal cost rises. A similar relationship links the average product and average variable costs.
