StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...
Free

Costs, Revenues and Production Decisions - Essay Example

Cite this document
Summary
Costs, Revenues and Production Decisions Introduction A firm’s production decision is critically dependent upon its revenue and costs. In particular, the firm’s objective is to maximize its profits. This involves identifying the level of output that maximizes its profits…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER91.5% of users find it useful
Costs, Revenues and Production Decisions
Read Text Preview

Extract of sample "Costs, Revenues and Production Decisions"

Costs, Revenues and Production Decisions Introduction A firm’s production decision is critically dependent upon its revenue and costs. In particular, the firm’s objective is to maximize its profits. This involves identifying the level of output that maximizes its profits. The profits of a firm in essence are the total revenue net of total costs. Both these variables, total revenues and total costs depend upon the level of output produced. Additionally, the price charged per unit of the product influences the total revenue.

Therefore, whenever a firm tries to maximize its profits, it is trying to identify the level of output and the price per unit to be charged so that the revenue is maximized and the costs are minimized so that profits are maximized. In the following, this paper shall elaborate upon how cost curves and revenues play into the production decisions. The discussion will initiate by reviewing the notions of costs and revenues and how these are related to the production decision of the firm. Then the discussion shall move on to show how considerations of costs and revenues impact the production decision.

Finally, the paper will conclude with a summary of the findings. Costs and output The primary decision that a producer has to take is to choose its input mix. Each possible input combination given the factor prices, is associated with a particular cost. The firm’s challenge is to identify the combination of inputs that is most efficient, i.e., the combination of inputs that yields the maximum output at some given level of cost, or for some given level of output the efficient input combination minimizes the total cost.

Thus, the least cost combination of inputs is known as efficient. Production in the short run involves some fixed costs, i.e., costs that do not depend upon the level of output as well as variable costs, i.e., costs that vary with the level of output. The efficient combination of inputs minimizes these variable costs. To keep things simple typically only two factors of production, capital (K) and Labour (L), are assumed. Capital is assumed to be fixed in the short run and the variable costs are due to varying labour input.

Due to the law of variable proportions, the productivity of labour initially increases and then after a certain extent decreases. As a result, the amount of labour required to produce an additional unit of output first falls at a declining rate, slows down and then starts rising at a rising rate. Hence the total variable cost curve is shaped like a tilted “s”. The fixed cost is simply a horizontal straight line and adding these two, the firm’s total cost curve is obtained. It is shown in the diagram below.

Figure 1: Variable, Fixed and Total Costs Revenue and output A firm’s total revenue is simple equal to the number of units sold times the price of the product. If P be the per-unit price and q be the number of units sold, then the total revenue (TR) is simply pq. Now, quantity of output, q has two channels of affecting the revenue. First, if q rises, given p, total revenue rises. However, as q rises, by the law of demand, the market price, p falls. Therefore, TR tends to drop. Whether a price change results in a rise or fall in total revenue actually depends upon the price elasticity of demand of that product.

However, that topic is beyond the scope of the present discussion. We proceed by making the simplifying assumption that the producer operates in a competitive market so that the market price does not depend upon changes in q (recall that a perfectly competitive producer is a price taker). Thus, with given p, total revenue becomes proportional to quantity of output and therefore can be represented by a straight line with a positive slope and zero intercept. Figure 2: The total revenue curve The production decision As briefly mentioned in the introduction, the producer’s objective is to maximize its profits, i.e., the difference between total revenue and total costs.

The discussion above implies that this boils down to identifying the level of output that leads to the biggest gap between total revenue and total costs. The analysis is carried out graphically in figure 3. Observe that initially, as output starts rising, total costs lie above total revenue. Therefore in this phase the producer makes losses. As he increases production, TR rises, and the increased productivity leads to a drop in per unit costs. Consequently, the losses start falling, come down to zero, and then profits start becoming positive.

Evidently, the profits are maximized at the level of output where the vertical distance between TR and TC is maximum, and this happens for the level of output where the slopes of these curves are equal. Since the slopes represent the marginals, the profit maximizing output is thus identified by the condition: Marginal Revenue = Marginal Cost or MR=MC. For all output levels where MR>MC, the firm can expand production and increase its profits. For all output levels when MR

Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(“Costs, Revenues and Production Decisions Essay Example | Topics and Well Written Essays - 750 words”, n.d.)
Costs, Revenues and Production Decisions Essay Example | Topics and Well Written Essays - 750 words. Retrieved from https://studentshare.org/macro-microeconomics/1445699-cost-curves-revenues-production-decisuons
(Costs, Revenues and Production Decisions Essay Example | Topics and Well Written Essays - 750 Words)
Costs, Revenues and Production Decisions Essay Example | Topics and Well Written Essays - 750 Words. https://studentshare.org/macro-microeconomics/1445699-cost-curves-revenues-production-decisuons.
“Costs, Revenues and Production Decisions Essay Example | Topics and Well Written Essays - 750 Words”, n.d. https://studentshare.org/macro-microeconomics/1445699-cost-curves-revenues-production-decisuons.
  • Cited: 0 times

CHECK THESE SAMPLES OF Costs, Revenues and Production Decisions

Production, Costs and Profits

production, Costs And Profits [University] [Instructor Name] Q:1 The manager of the restaurant needs to consider several factors before deciding whether to purchase a new grill and French fry machine or to employ additional workers as suggested by its supervisor.... hellip; Firstly, the manager should consider the costs of additional capital as compared to cost of employing new workers.... Under such, if the capital has reached its limit/full capacity, the manager of the restaurant should consider adding a new grill and French fry machine as adding workers will only add to the costs and will not solve the problem (Rittenberg & Tregarthen, 2009, Chapter 8)....
4 Pages (1000 words) Essay

Supply: Production, Costs, and Profits

Title: Supply - production, Costs, and Profits Name: Professor: Institution: Course: Date: 1.... They do not increase or reduce with the level of production.... These include cost of purchasing land and machinery necessary for production to take place.... Fixed cost is also referred to as total fixed cost (TFC) Variable Costs (TVC): These are costs which increase or decrease with the level of production.... It is the change in total cost as a result of an increase in production by one unit....
4 Pages (1000 words) Essay

Markets, Profits and Prices of Boeing

hellip; The author states that in the context of production, fixed costs are costs that do not change with the level of output they produce.... The production of commercial aircraft involves advanced technological process and highly automated sophisticated machinery, which should be very expensive.... The major variable costs for Boeing are materials used for aircraft production (i.... “The marginal cost of production is the increase in total costs resulting when output is increased by one unit” (Barron, Lynch & Blanchard, 2003, p....
8 Pages (2000 words) Case Study

Macroeconomics: Production Costs

This term paper discusses the production costs that business organizations incur in the process of creating goods for consumption.... This paper also talks about the broad categories of production costs, subdivisions, as well as examples of each category and subdivision.... Costs of producing a commodity is influenced by the cost of technology used, resources applied, as well as the costs of inputs employed in the production process, and are inevitable and usually included within commodity prices....
15 Pages (3750 words) Term Paper

Absorption Costing versus Variable Costing

Absorption and variable costing are one of the important costing techniques which facilitate an organization to allocate organizational expenses against revenues and determine profits.... GAAP does not allow the usage of variable costing for estimating the cost of production.... The variable costing technique includes only the variable production costs.... However these costs are not recognized till the firm sells the goods and revenues are earned....
7 Pages (1750 words) Essay

Cost, Budgets and Strategic Decision Making in Management Accounting

Second, the production facility budget is prepared.... The production budget is grounded on the projected next accounting period's revenues.... If the next accounting period's expected revenues is 50 cars and the last month's unsold cars is 15 cars, then the production budget will be to produce only the remaining 35 cars [50 cars revenue – 15 unsold cars from the prior accounting period = 35 cars] (Warren, 2015).... The marketing The projected next period's revenues are normally grounded on the prior accounting periods' actual revenue trends....
5 Pages (1250 words) Assignment

Accounting for Decision Makers -Discussion Question

Jointly manufactured products are dependent on similar raw materials and production process.... Jointly manufactured products are dependent on similar raw materials and production process.... Joint products share raw materials and production process up to a point known as split-off.... The decision to sell-or-process further is based on the cost-benefit analysis of the two decisions.... Based on the case of the Port Allen Chemical company, raw material D is used in the production of products E and F....
1 Pages (250 words) Assignment

Cost Control and Performance Management

The strategic decisions are the entire basis for decisions which are supposed to be well thought out.... Also, the decisions are mainly subjective, they are not concrete.... This is done to help with the process of making managerial decisions.... When costing is done in this method then, all costs are treated as the cost of production.... The costing method allocates part of the fixed manufacturing overhead cost to every single unit of production....
9 Pages (2250 words) Case Study
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us