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					          Production, Costs and Revenue
                    AS Economics
tutor2u
 Short and long run production
          • Production refers to the output of goods and services
            produced within a market
          • Short run production
             – The short run is a period of time when there is at least
               one fixed factor of production. This is usually the
               capital input such as plant and machinery and the
               stock of building and technology
             – In the short run, output expands when more variable
               factors (labour, raw materials and components) are
               employed
          • Long run production
             – In the long run, all factors of production can change as
               a business can increase the scale of its operations
tutor2u
 In the short run

                    • In the short run
                      we assume that
                      a business is
                      operating with a
                      fixed amount of
                      capital and a
                      given state of
                      technology
                    • How does
                      production
                      increase in the
                      short run?

tutor2u
 In the long run
          • In the long run, all of
            the factors of
            production are
            variable
          • The whole scale of
            production can
            change
          • Businesses in the
            long run can take         The warehouse at
            advantage of              Amazon UK in
            economies of scale        Northamptonshire



tutor2u
 The Production Function
          • Output (Q) = f (K, L, La, T)
          • Where
             – Q = output per period
             – K = capital input
             – La = labour input
             – L= natural resource input (land)
             – T= the state of technology




tutor2u
 The law of diminishing returns
          • Marginal product (MP) = Change in total output from
            adding one extra unit of labour
          • Average product (AP) = Total Output divided by the
            total units of labour employed
          • Diminishing returns occur when the marginal product
            of labour starts to fall
             – The Law of Diminishing Returns occurs because
               factors of production are not perfect substitutes for
               each other
             – Resources used in producing one type of product are
               not necessarily as efficient when switched to the
               production of another good or service

tutor2u
 Marginal and average product
          Units of Labour   Total Physical Product   Marginal Product    Average Product
          Employed          (tonnes of wheat)        (tonnes of wheat)   (tonnes of wheat)
          0                 0

          1                 3                        3                   3

          2                 10                       7                   5
          3                 24                       14                  8
          4                 36                       12                  9
          5                 40                       4                   8
          6                 42                       2                   7
          7                 42                       0                   6


              When does diminishing returns start to occur here?
              When is output per worker at a maximum?
              What is the relationship between marginal product and
              average product?
tutor2u
 Fixed and variable costs of production
          • Costs are those expenses faced by a business when
            producing a good or service for a market
          • Total Cost
             – Total Cost is made up of fixed costs and variable costs
          • Fixed Costs
             – These costs relate to the fixed factors of production
               and do not vary directly with the level of output
          • Variable Costs
             – Variable costs vary directly with output. I.e. as
               production rises, a firm will face higher total variable
               costs because it needs to purchase extra resources to
               achieve an expansion of supply
tutor2u
 Fixed and variable costs - SpeedFerry




          Identify some of the fixed and variable costs facing the
          SpeedFerry business as it competes in the cross-
          channel transport market
tutor2u
 Average fixed costs fall as output rises

          Output   Total Fixed Costs   Average Fixed Cost
          (000s)        (£000s)              (AFC)
             0             30
             1             30                 30
             2             30                 15
             3             30                 10
             4             30                 7.5
             5             30                  6
             6             30                  5
             7             30                 4.3




tutor2u
 Average Fixed Costs

          Costs
                      Average fixed cost falls as output increases
                      – because fixed costs are being spread over
                      a higher level of production




          £30k                                                       Total Fixed Costs




                                                      Average Fixed Cost

                  1                                                        Output (Q)




tutor2u
 Example of operating costs - Ryanair
                                           2004 (million Euro)

          Staff costs                      123.6

          Depreciation of capital          98.1

          Fuel and oil                     175.0

          Maintenance / materials / repairs 43.4

          Aircraft rentals                 11.5

          Route charges                    110.3

          Airport and handling charges     147.2

tutor2u
 Ryanair’s Business Model
          • Low operating costs
          • High load factor (% of flight seats booked is high)
          • Aggressive route expansion (network economies)
          • Growth of ancillary revenues (car hire, hotels, in-flight
            entertainment)
          • Low prices (exploiting the concept of price elasticity
            of demand)




tutor2u
 Threats to Ryanair
          • Volatility of fuel prices
          • Fluctuations in the exchange rate
          • External shocks such as terrorist attacks
          • Pricing strategies of other airlines
          • Introducing of a aviation fuel tax to control pollution
          • Regulatory decisions of international bodies




tutor2u
                  Revenue and Profit
          Revision presentation on revenue and profit
tutor2u
 Total Sales Revenue

                        Supply
          Price

                                       Revenue at
                                      price P1 and
                                       output Q1


             P1




                        D1       D2


                   Q1                     Quantity



tutor2u
 Total Sales Revenue – Shift in demand

                            Supply
          Price

                                           Revenue at
                                          price P2 and
                                           output Q2
             P2
             P1




                            D1       D2


                    Q1 Q2                     Quantity



tutor2u
 Costs and Revenues
          Output    Total   Average Total   Marginal   Price per unit      Total   Profit (loss)
          (units)   Cost            Cost       Cost        (demand)     Revenue
                0    100
              20     140               7          2                8        160              20
              40     160               4          1              7.5        300             140
              60     174              2.9        0.7               7        420             246
              80     184              2.3        0.5             6.5        520             336
             100     190              1.9        0.3               6        600             410
             120     204              1.7        0.7             5.5        660             456
             140     238              1.7        1.7               5        700             462
             160     288              1.8        2.5             4.5        720             432
             180     360               2         3.6               4        720             360
             200     460              2.3         5              3.5        700             240
             220     660               3         10                3        660               0




tutor2u

				
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