MOD2-EMrev(prev) - Entreprenurial Mind PDF

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MODULE 2. PRODUCTION AND COSTS (Introductory Supply-Side Economics)Production is the creation of utilities (anything which can satisfy human wants). We alsodiscussed during our first meeting that it is the second division in the field of Economics, comingright after Consumption. And that, there is p...

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MODULE 2. PRODUCTION AND COSTS (Introductory Supply-Side Economics) Production is the creation of utilities (anything which can satisfy human wants). We also discussed during our first meeting that it is the second division in the field of Economics, coming right after Consumption. And that, there is production because there is consumption. In this module, we will be reviewing (because I am assuming you have taken these basic concepts in your high school) the core concepts in Production (or the introductory part of Supply-Side Economics). It is essential because we have to start on the same page, as in the concepts that you have learned before or that which you may have had faulty understanding or misunderstood needs to be clarified. Our learning in this course is sequential and it is important that you understand all the basic concepts and terms as well as the core theories and principles because all these may come in handy when you become an entrepreneur or perhaps, an investor. And now, we continue with the factors of production which in Classical Economics, only number four (4) but in modern times there are five (5) although not seen in most references since most are advocates of Adam Smith, being the Father of Economics and the proponent of Classical Economics. Module Learning Outcomes A. Acquire a comprehensive understanding of the basic principles/theories/concepts in Production for use in entrepreneurship and/or investments. B. Evaluate/assess selected economic indicators in Production for current and relevant day-to-day utilization. LESSON 1. PRODUCTION PRINCIPLES/THEORIES AND RELATED CONCEPTS (Part One) Learning Outcomes: A. To define and deepen the understanding of the key concepts in Production. B. Compute, interpret and apply the key Production concepts to present-day conditions. Learning Content: 1. Origin, Nature and Value of Production 2. Production Periods (Short-run, Long-run, Very Short-run/Market Period) 3. Production Function 4. Profit Maximization (MC=MR approach)

MODULE 2. Production and Costs (Introd. Supply-Side Econ.) LESSON 1. Production Principles/Theories and Related Concepts (Part One) Learning Content: Factors of Production A factor of production is anything used to produce a good or service. It was mentioned in the previous discussion that there are, traditionally, four (4) broad categories of factors of production. Land (L) is a broad measure representing all the basic natural resources that contribute to production. The economic return or payment for this factor of production is called rent (r). Labor (L) represents the human factor of production which includes both physical and mental efforts. The economic return or payment to labor is called wage (w). Capital (K) includes previously produced

durable goods that aid in producing still other goods. The three (3) requirements of capital are found in the technical definition of capital. Capital is (1st) any form of wealth which is (2nd) man-made or a product of the past history of man and is (3rd) used to further produce more wealth. Interest (i) is the economic return to capital. Entrepreneur or Entrepreneurship includes the managerial ability, innovation, and risktaking that contribute to a productive economy. The entrepreneur is often referred to as the captain of industry because he manages and assumes all the risks n production. The economic return to entrepreneurship is called profit (π). Production Periods When one undertakes production, there exists two (2) distinct time frames: the short-run (SR) period and the long-run (LR) period. The short-run period is any period during which the usable amount of at least one input is fixed. The long-run period is a period during which the amounts of all inputs used can be changed. Furthermore, the SR and LR periods are not determined by the calendar. They are determined by the ability to change the rate of use of the factors of production. There are three (3) measures of production/productivity and these are: 1. Total Product or TP is the total output that is generated from the factors of production employed by a business. 2. Average Product or AP is the total output divided by the number of units of the variable factor of production employed (e.g. output per worker employed or output per unit of capital employed). 3. Marginal Product or MP is the change in TP when an additional unit of the variable factor of production is employed (i.e. MP would measure the change in output that comes from increasing the employment of labor by one person, or by adding one more machine to the SR production of a firm. Production Function Defined as the technical relationship showing the maximum amount of output capable of being produced by each and every set of specified factors of production or factor inputs. The quantity of output of the goods depends on the quantities of the input X1 (labor), X2 (machinery), X3 (raw materials) form the equation where P = f (X1+X2+X3+…Xn) and, where X1, X2, X3, … Xn are inputs. Thus, a production function affirms that the maximum output of a technologically-determined production process is a mathematical function of input factors of production. And considering the set of all technically feasible combinations of output and inputs, only the combinations containing a maximum output for a specified set of inputs would constitute the production function. It is important to note also that a production function deals with the specification of the minimum input requirements needed to produce designated quantities of output, given available technology. Lastly, keep in mind that the production function describes technology, not economic behavior and so, the main goal of the producer is to maximize his profits and that he utilizes his technology towards efficient production. Profit Maximization Since the goal of the producer is to maximize his profits, one (1) approach that may be used is the MC=MR approach where MC is the Marginal Cost (or the difference, or increment, between total costs at a higher and a lower level of output, divided by the number of units produced)) and MR is the Marginal Revenue (or the difference between total revenue from sales at two different levels of output

divided by the quantity of goods produced). And in order to arrive at this profit maximization equation, the following formulas (both on the cost side and revenue side in production) have to be considered: Cost Side  Total Cost (TC) = Fixed Cost (FC) + Variable Cost (VC)  Average Fixed Cost (AFC) = FC/Q  Average Variable Cost (AVC) = VC/Q  Average Total Cost (ATC) or Average Cost (AC) = AFC+AVC or AC/Q (Note: it is suggested that you use the second formula for class uniformity)  Marginal Cost (MC) = Present TC minus Previous TC/ Present Q minus Previous Q (or the Difference in Total Costs divided by Difference in Quantities) Revenue Side  Total Revenue (TR) = P Q (or Price multiplied to Quantity)  Average Revenue (AR) = TRQ (TR divided by Q) = Price (P)  Marginal Revenue (MR) = Present TR minus Previous TR/Present Q minus Previous Q (or Difference in Total Revenues divided by the Difference in Quantities Note: Once you have the MC and the MR per level you can now evaluate if the producer attained profit maximization based on the three (3) expected outcomes: MC MR; MC MR or MC = MR Fast Fact: There are two (2) approaches for profit maximization: TR-TC Approach and MC=MR Approach Assigned Activity: 1. Matrix Construction and Computation Construct a matrix given the data and answer the questions which follow: 3.1 Three (3) levels of production Level 1 has a volume of production of 10,000; Fixed Cost of 5,000; Total Cost of 15,000; and a Price of 2.25 Level 2 has a quantity of 25,000; Variable Cost of 17,000; and a Price of 1.50 Level 3 has Production Volume of 50,000; Total Cost of 50,000; and a Price of 5.00 You are to assume that our seller is trying to maximize his profits (and he knows that the profit maximization formula is MC=MR), evaluate if he was able to maximize his profits at Productions Levels I, II, and III. Why or why not?

References:  DE JESUS, Maria Bernadette A., RIOS, Donna Teresita M., MERCADO-CRUZ, Ma. Theresa. EconCART, Revised Edition. Books Atbp. Publishing Corp. Mandaluyong. 2016. ISBN 978-621-409-019-8  SINGER, Leslie P. Economics Made Simple. Doubleday & Company, Inc. New York. 1967.

LESSON 2. PRODUCTION PRINCIPLES/THEORIES AND RELATED CONCEPTS (Part Two) Learning Outcomes: A. To define and deepen the understanding of the key concepts in Production. B. Compute, interpret and apply the key Production concepts to present-day conditions. Learning Content 1. Cost Conditions 2. Production Possibilities Curve

3. Least Cost Combination Method (Isoquant-Isocost Approach) 4. Market Structures (from the Seller’s viewpoint) 4.1. Pure Competition 4.2. Monopoly 4.3. Monopolistic Competition 4.4. Oligopoly LESSON 2. Production Principles/Theories and Related Concepts (Part Two) Learning Content Cost Conditions The costs that a company incurs represent payments to factors of production or factor inputs thereby stressing the fact that all costs are related to the factors of production at some stage in the production process. And just as the weighted average of grades determine the student’s performance, somehow the average costs (also the unit costs) in production show the status of operations. How the average cost behaves determine to a great extent the cost conditions. When average cost remains at the same level as output is increased, the industry is said to be operating under constant cost conditions. An industry is under Constant Cost conditions when the supply price remains the same for all levels of outputs, and also as one in which the prices of factor inputs do not change as output changes. If average cost goes up as output increases, Increasing Cost conditions are predominant. An increasing cost industry is one where the supply price increases as the output is increased, and where the prices of the factor inputs vary directly as the output varies. Increasing Cost conditions also mean Decreasing Returns which can be attributed to increases in the prices of factor inputs as more units of production factors are used or to some other causes which are outside or external to the industry itself (otherwise known as Internal and External Economies or Diseconomies of Scale). Finally, in the case of Decreasing Cost industries, the supply price behaves inversely with output that is, as output increases (decreases) the supply price decreases (increases). Decreasing Cost industries are also known as industries operating under Increasing Returns. These industries enjoy the benefits of economies of large-scale production. These are the cost advantage that enterprises obtain due to size output or scale of operation with cost per unit of output generally decreasing with increasing scale as fixed costs are spread out over more units of output. These cost conditions are significant to the industry because in a way they determine the quantity of goods that will be supplied at a given market price. Production- Possibility Curve (Frontier/Schedule) The scarcity of resources necessitates a choice between scarce commodities. A full-employment economy for one, must generally produce one commodity by giving up something of another. Substitution is the law of life in a full-employment economy. The Production-Possibility Frontier depicts the menu of choices of society. The Production-Possibility Curve or P-PC is a curve on the graph indicating alternative combinations of two commodities or categories of commodities that can be produced when all the available factors of production are efficiently employed. Or the combinations of output that the economy can possibly produce given the available factors of production and the available production technology. Given the available resources and technology, the P-PC sets the boundary between which combination is attainable and which it is unobtainable. Least-Cost Combination Method (Isoquant-Isocost Approach)

Given that the producer aims to attain profit maximization, he will mix and match or combine his factor inputs in the best possible way to achieve productivity or efficiency in production. Efficiency in Economics is focusing, not only in profit maximization, but also in cost minimization. This is the perception that some experts in the field are trying to put forward – minimizing your costs can be equated to maximizing your profits. Since during operations, the producer, even if he had planned his production to perfection in terms of his output based on the demands of the industry and/or market, it is not an assurance that he will be able to sell all that he produced. Thus, it would be a smart if not a wise move to already cut costs or lessen/minimize his production costs. This is where the notion of Least-Cost Combination came into the forefront and that is, being cost-efficient in order to be more profitable. How else can countries who export to LDCs like the Philippines sell their products cheaper compared to locally-manufactured counterparts? Less expensive imports for us, more often than not, is a result of cost-efficient production in other countries. As the term connotes, the producer must eventually opt for the that factor input combination that will yield the least cost. And the approach for this method is the Isoquant-Isocost Approach. The isoquant curve is also called the equal product curve, the production indifference curve or constant product curve. It indicates various combinations of two (2) factors of production which give the same level of output per unit of time. The isocost line or curve is the producer’s budget line. It illustrates all the possible combinations of two (2) factors that can be used at given costs and for a given producer’s budget. Market Structures From the point of view of the seller, there are four (4) market classifications or structures. A. Pure Competition - a theoretical concept defined as a state of affairs where each seller and each buyer are too small, relative to the total market, to be able to influence market price when acting independently. To be more specific, there are certain conditions to be met for the Classical Model to work as planned: 1. There is a large number of buyers and sellers acting independently such that no one buyer or seller will affect the price. 2. The products offered for sale should be sufficiently alike or homogeneous for buyers to feel free to choose the products offered by sellers. 3. There is freedom of entry or exit to the market 4. There is knowledge of market(s) for both buyers and sellers in terms of prices, quantities, and quality. B. Monopoly – a type of market organization or market structure in which a single large producer is selling a product which is perfectly differentiated from all other products in the market. Its two (2) basic characteristics are: 1. One big seller (i.e. the firm is not the only seller in the particular industry but instead the firm is the Number 1 in the industry; unless the firm is the only one in the industry. 2. The product is unique. C. Monopolistic Competition – competition between monopolists selling differentiated products or characterized as a market in which there are enough sellers that act independently of the others and it applies the analysis of differentiated products. By far, this theory has been most useful in analyzing two (2) situations – Geographic Differentiation and Product Differentiation. Its characteristics are: 1. These firms sell differentiated products. 2. There is freedom of entry or exit to the market i.e. new firms can enter freely and established firms can exit. 3. Firms exert a limited degree of control over their price.

D. Oligopoly – a market structure consisting of a few large sellers producing an identical product or products between which the consumer does not significantly differentiate. Or a market situation where there are few firms offering standardized or differentiated goods and services. An Oligopoly is an industry characterized by: 1. The relatively small number of firms in the industry. 2. Moderate to high barriers entry. 3. The production can be either homogeneous or differentiated products. 4. Price researching since oligopolies are able to exercise some control over price. 5. Recognize mutual interdependence. Fast Fact: In actual market, whether this market be competitive, oligopolistic or monopolistic, the price of a given commodity is related to the prices of other goods or services and these prices of commodities are highly interrelated and interdependent This degree of interdependence may either be positive (or with a direct relationship) or negative (inversely-related). Assigned/Suggested Activities: 1. Complete the Table Below is a table showing five (5) combinations of factor inputs (labor and capital). Using the formula TC= Price of L (Labor Q) + Price of K (Capital Q), you are to compute for the Total Costs to enable you to identify the production with the Least-Cost Combination(L-CC). Indicate the L-CC by placing a star on the Remark column where the combination is. Combination Output

Units of Labor Labor(L) Costs A 10,000 5,000 B 10,000 1,000 C 10,000 3,000 D 10,000 1,500 E 10,000 2,000 Price of Labor per unit: PhP 50.00 Price of Capital per unit: PhP 100.00

Units of Capital Capital(K) Costs 5,000 9,000 7,000 8,500 8,000

Total Costs

Remark

References:  DE JESUS, Maria Bernadette A., RIOS, Donna Teresita M., MERCADO-CRUZ, Ma. Theresa. EconCART, Revised Edition. Books Atbp. Publishing Corp. Mandaluyong. 2016. ISBN 978-621409-019-8  MANKIW, Gregory N. Macroeconomics, Eighth Edition. Cengage Learning. Massachusetts. 2018. ISBN 13: 978-1-305-97150-9  SINGER, Leslie P. Economics Made Simple. Doubleday & Company, Inc. New York. 1967.

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