Production costs in the short run are divided into fixed and variable.
Fixed costs (TFC) are production costs that do not depend on the firm's output and must be paid even if the firm does not produce anything. Associated with the very existence of the firm and depend on the amount of fixed resources and the corresponding prices of these resources. These include: executive salaries, loan interest, depreciation, space rent, cost of equity, and insurance payments.
Variable costs (TVC) are such costs, the value of which varies depending on the volume of output, this is the sum of the firm's costs for variable resources used in the production process: wages of production personnel, materials, electricity and fuel, transportation costs. Variable costs increase as the volume of production increases.
General (cumulative) costs (TC) are the sum of fixed and variable costs: TC=TFC+TVC. At zero output, variable costs are zero, and total costs- fixed costs. After the start of production in the short run, variable costs begin to rise, causing an increase in general costs.
The nature of the curves of total (TC) and total variable costs (TVC) is explained by the principles of increasing and diminishing returns. As returns increase, the TVC and TC curves rise to a decreasing degree, and as returns begin to fall, costs rise to an increasing degree. Therefore, to compare and determine the efficiency of production, average production costs are calculated.
Knowing the average cost of production, it is possible to determine the profitability of producing a given quantity of products.
Average production costs are the costs per unit of output. Average costs, in turn, are divided into average fixed, average variable and average total.
Medium fixed costs(AFC) - represent fixed costs per unit of output. AFC=TFC/Q, where Q is the number of products produced. Since fixed costs do not vary with output, average fixed costs decrease as the number of products sold increases. Therefore, the AFC curve falls continuously as output rises, but does not cross the output axis.
Average Variable Costs (AVC) are the variable costs per unit of output: AVC=TVC/Q. Average variable costs are subject to the principles of increasing and decreasing returns to factors of production. The AVC curve has an arcuate shape. Under the influence of the principle of increasing returns, average variable costs initially fall, but after reaching a certain point, they begin to increase under the influence of the principle of diminishing returns.
Exists inverse relationship between the variable cost of production and the average product of the variable factor of production. If the variable resource is labor (L), then the average variable cost is wages per unit of output: AVC=w*L/Q (where w is the rate wages). Average product of labor APL = output per unit of factor used Q/L: APL=Q/L. Result: AVC=w*(1/APL).
Average total cost (ATC) is the cost per unit of output. They can be calculated in two ways: by dividing the total cost by the quantity produced, or by adding the average fixed and average variable costs. The AC curve (ATC) has an arcuate shape like average variable costs, but exceeds it by the amount of average fixed costs. As output increases, the distance between AC and AVC shortens due to the faster decline in AFC, but never reaches the AVC curve. The AC curve continues to fall after an AVC-trough release, because AFCs that continue to decline more than offset weak AVC gains. However, with a further increase in production, the increase in AVC begins to outstrip the decrease in AFC, and the AC curve turns up. The minimum point of the AC curve determines the most efficient and productive level of production in the short run.
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The concept of average costs. Average fixed costs (AFC), average variable costs (AVC), average total costs (ATC), concept marginal cost(MS) and their graphs.
Average cost is the value of the total costs attributable to the value of the product produced.
Average costs are further divided into average fixed costs and average variable costs.
Average fixed costs(AFC) is the amount of fixed costs per unit of output.
Average variable costs(AVC) is the amount of variable costs per unit of output.
Unlike average fixed costs, average variable costs can both decrease and increase as output increases, which is explained by the dependence of total variable costs on output. Average variable costs reach their minimum at the volume that provides the maximum value of the average product
Average total cost(ATC) is the total cost of production per unit of output.
ATC = TC/Q = FC+VC/Q
marginal cost is the increase in total costs caused by an increase in output per unit of output.
Curve MC intersects AVC and ATC at points corresponding to the minimum value of the average variables and average total costs.
Question 23. Production costs in the long run. Depreciation and amortization. The main directions of use of depreciation funds.
The main feature of costs in the long run is the fact that they are all variable - the firm can increase or decrease capacity, and it also has enough time to decide to leave this market or enter it from another industry. Therefore, in the long run, they do not single out average fixed and average variable costs, but analyze the average cost per unit of output (LATC), which in essence are both average variable costs.
Depreciation of fixed assets (funds ) - a decrease in the initial cost of fixed assets as a result of their wear and tear in the production process (physical wear) or due to the obsolescence of machines, as well as a decrease in the cost of production in the context of an increase in labor productivity. Physical deterioration fixed assets depends on the quality of fixed assets, their technical improvement (design, type and quality of materials); features of the technological process (speed and cutting force, feed, etc.); the time of their action (number of days of work per year, shifts per day, hours of work per shift); degree of protection from external conditions (heat, cold, humidity); the quality of care for fixed assets and their maintenance, from the qualifications of workers.
Obsolescence- decrease in the cost of fixed assets as a result of: 1) a decrease in the cost of production of the same product; 2) the emergence of more advanced and productive machines. The obsolescence of means of labor means that they are physically suitable, but do not justify themselves economically. This depreciation of fixed assets does not depend on their physical depreciation. A physically fit machine can be so morally obsolete that its operation becomes economically unprofitable. Both physical and moral deterioration leads to a loss of value. Therefore, each enterprise should ensure the accumulation of funds (sources) necessary for the acquisition and restoration of finally depreciated fixed assets. Depreciation(from the middle - century. lat. amortisatio - redemption) is: 1) the gradual depreciation of funds (equipment, buildings, structures) and the transfer of their value in parts to manufactured products; 2) decrease in the value of taxable property (by the amount of capitalized tax). Depreciation is due to the peculiarities of the participation of fixed assets in the production process. Fixed assets are involved in the production process for a long period (at least one year). At the same time, they retain their natural shape, but gradually wear out. Depreciation is charged monthly at the established rates depreciation charges. The accrued depreciation amounts are included in the cost of products or distribution costs, and at the same time, due to depreciation deductions, sinking fund, used for full recovery and overhaul of fixed assets. Therefore, proper planning and the actual calculation of depreciation contributes to the accurate calculation of the cost of production, as well as to the determination of sources and amounts of financing for capital investments and capital repairs of fixed assets. depreciable property recognized as property, results of intellectual activity and other objects of intellectual property that are owned by the taxpayer and are used by him to generate income and the cost of which is repaid by accruing depreciation. Depreciation deductions - accruals with subsequent deductions, reflecting the process of gradual transfer of the cost of labor instruments as they wear out and obsolescence to the cost of products, works and services produced with their help for the purpose of accumulation Money for a full recovery. They are accrued both for tangible assets (fixed assets, low-value and wearing items) and for intangible assets (intellectual property). Depreciation deductions are made according to established depreciation rates, their amount is set for a certain period for a specific type of fixed assets (group; subgroup) and is usually expressed as a percentage per year of depreciation to their book value. Sinking fund - source of capital repairs of fixed assets, capital investments. Formed from depreciation charges. Depreciation task (depreciation) - to allocate the cost of durable tangible assets to costs over the expected life based on the application of systematic and rational records, i.e. it is a process of distribution, not evaluation. V this definition there are several important points. First, all durable tangible assets other than land have a finite life. Due to the limited life of these assets, the cost of these assets must be allocated to costs over all the years of their operation. The two main reasons for the limited life of assets are depreciation and obsolescence (obsolescence). Periodic repairs and careful maintenance can keep buildings and equipment in good condition and greatly extend their life, but eventually every building and every machine must fall into disrepair. The need for depreciation cannot be eliminated by regular repairs. Obsolescence is the process by which assets do not meet modern requirements due to progress in the development of technology and for other reasons. Even buildings often become obsolete before they physically wear out. Second, depreciation is not a cost appraisal process. Even if the market price of a building or other asset may rise as a result of a good deal and specific market conditions, depreciation should still be accrued (accounted for), because it is a consequence of the allocation of previously incurred costs, and not a valuation. Determining the amount of depreciation for the reporting period depends on: the initial cost of objects; their salvage value; depreciable cost; expected useful life.
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Classification of the firm's costs in the short run.
When analyzing costs, it is necessary to distinguish between costs for the entire output, i.e. general (full, total) production costs, and unit production costs, i.e. average (specific) costs.
Considering the costs of the entire output, it can be found that when the volume of production changes, the value of some types of costs does not change, while the value of other types of costs is variable.
fixed costs(FC – fixed costs) are costs that do not depend on the volume of output. These include building maintenance costs, overhaul, administration and management expenses, rent, property insurance payments, certain types of taxes.
The concept of fixed costs can be illustrated in Fig. 5.1. Plot on the x-axis the amount of output (Q), and on the y-axis - costs (WITH). Then the fixed cost schedule (FC) will be a straight line parallel to the x-axis. Even when the enterprise does not produce anything, the value of these costs is not equal to zero.
Rice. 5.1. fixed costs
variable costs(VC – variable costs) are the costs, the value of which varies depending on the change in production volumes. Variable costs include the cost of raw materials, materials, electricity, wages of workers, the cost of auxiliary materials.
Variable costs increase or decrease in proportion to output (Fig. 5.2). On the initial stages prod
Rice. 5.2. variable costs
production, they grow at a faster rate than manufactured products, but as the optimal output is reached (at the point Q 1) the growth rate of variable costs is decreasing. In larger firms, the unit cost of producing a unit of output is lower due to the increase in production efficiency provided by more high level specialization of workers and more complete use of capital equipment, so the growth of variable costs is already slower than the increase in output. In the future, when the company exceeds its optimal size, the law of diminishing productivity (profitability) comes into play and variable costs again begin to overtake production growth.
Law of diminishing marginal productivity (profitability) states that, starting from a certain point in time, each additional unit of a variable factor of production brings a smaller increment in total output than the previous one. This law takes place when any factor of production remains unchanged, for example, production technology or the size of the production area, and is valid only for a short period of time, and not for a long period of human existence.
Let's explain how the law works with an example. Assume that the enterprise has a fixed amount of equipment and workers work in one shift. If the entrepreneur hires additional workers, then work can be carried out in two shifts, which will lead to an increase in productivity and profitability. If the number of workers increases even more, and workers begin to work in three shifts, then productivity and profitability will increase again. But if you continue to hire workers, then there will be no increase in productivity. Such a constant factor as equipment has already exhausted its possibilities. The application of additional variable resources (labor) to it will no longer give the same effect, on the contrary, starting from this moment, the costs per unit of output will increase.
The law of diminishing marginal productivity underlies the behavior of a producer who maximizes his profit and determines the nature of the supply function of the price (supply curve).
It is important for the entrepreneur to know to what extent he can increase the volume of production so that the variable costs do not become very large and do not exceed the profit margin. The difference between fixed and variable costs is significant. A manufacturer can control variable costs by changing the volume of output. Fixed costs must be paid regardless of the volume of production and are therefore beyond the control of the administration.
General costs(TS– total costs) is a set of fixed and variable costs of the firm:
TC= FC + VC.
Total costs are obtained by summing the fixed and variable cost curves. They repeat the configuration of the curve VC, but separated from the origin by the value FC(Fig. 5.3).
Rice. 5.3. General costs
For economic analysis, average costs are of particular interest.
Average cost is the cost per unit of output. The role of average costs in economic analysis is determined by the fact that, as a rule, the price of a product (service) is set per unit of production (per piece, kilogram, meter, etc.). Comparison of average costs with the price allows you to determine the amount of profit (or loss) per unit of product and decide on the feasibility of further production. Profit serves as a criterion for choosing the right strategy and tactics of the company.
There are two types of average costs:
Average fixed costs ( AFC - average fixed costs) - fixed costs per unit of production:
AFC= FC / Q.
As output increases, fixed costs spread across all large quantity products, so that the average fixed costs are reduced (Fig. 5.4);
Average variable costs ( ABC – average variable costs) - variable costs per unit of output:
AVC= VC/ Q.
As output grows ABC first they fall, due to the increasing marginal productivity (profitability) they reach their minimum, and then, under the influence of the law of diminishing productivity, they begin to grow. So the curve ABC has an arcuate shape (see Fig. 5.4);
average total cost ( ATS – average total costs) - total costs per unit of output:
ATS= TS/ Q.
Average cost can also be obtained by adding average fixed and average variable costs:
ATC= A.F.C.+ AVC.
The dynamics of average total costs reflects the dynamics of average fixed and average variable costs. While both are declining, the average total costs fall, but when, as output increases, the increase in variable costs begins to overtake the fall in fixed costs, the average total costs begin to rise. Graphically, average costs are represented by the summation of the curves of average fixed and average variable costs and have a U-shape (see Fig. 5.4).
Rice. 5.4. Production costs per unit of output:
MS - limit, AFC - average constants, AVC - average variables,
ATS - average total cost of production
The concepts of total and average costs are not enough to analyze the behavior of the firm. Therefore, economists use another type of cost - marginal.
marginal cost(MS – marginal costs) is the cost associated with producing an additional unit of output.
The category of marginal cost is of strategic importance, because it allows you to show the costs that a firm will have to incur if it produces one more unit of output or
save in the event of a reduction in production for this unit. In other words, marginal cost is the amount that a firm can directly control.
Marginal cost is obtained as the difference between the total cost of production ( n+ 1) units and production costs n product units:
MS= TSn+1 – TSn or MS= D TS/D Q,
where D is a small change in something,
TS- general costs;
Q- volume of production.
Graphically, marginal costs are shown in Figure 5.4.
Let us comment on the main relationships between average and marginal costs.
1. Marginal cost ( MS) do not depend on fixed costs ( FС), since the latter do not depend on the volume of production, but MS are incremental costs.
2. As long as marginal costs are less than average ( MS< AC), the average cost curve has a negative slope. This means that the production of an additional unit of output reduces the average cost.
3. When marginal costs are equal to average ( MS = AC), which means that average costs have stopped decreasing, but have not yet begun to grow. This is the point of minimum average cost ( AC= min).
4. When marginal costs become greater than average ( MS> AC), the average cost curve goes up, which indicates an increase in average cost as a result of the production of an additional unit of output.
5. Curve MS crosses the average variable cost curve ( AVC) and average costs ( AC) at their points minimum values.
To calculate costs and evaluate the production activities of enterprises in the West and in Russia, they use various methods. In our economy, methods based on the category prime cost, including the total cost of production and sale of products. To calculate the cost, the costs are classified into direct, directly going to the creation of a unit of goods, and indirect, necessary for the functioning of the company as a whole.
Based on the previously introduced concepts of costs, or costs, we can introduce the concept added value, which is obtained by subtracting from the total income or revenue of the enterprise variable costs. In other words, it consists of fixed costs and net profit. This indicator is important for assessing production efficiency.
Question 10. Types of production costs: fixed, variable and general, average and marginal costs.
Each firm in determining its strategy focuses on maximizing profits. At the same time, any production of goods or services is unthinkable without costs. The company incurs specific costs for the acquisition of factors of production. In doing so, it will seek to use such manufacturing process, at which a given volume of production will be provided at the lowest cost for the applied factors of production.
The cost of acquiring the factors of production used is called production costs. Costs are the expenditure of resources in their physical, in kind, and costs - the valuation of the costs incurred.
From the point of view of an individual entrepreneur (firm), there are individual production costs, representing the costs of a particular business entity. The costs incurred for the production of a certain volume of some product, from the point of view of the entire national economy, are public costs. In addition to the direct costs of producing a range of products, they include costs for environmental protection, training a skilled workforce, basic R&D, and other costs.
Distinguish between production costs and distribution costs. Production costs are the costs directly associated with the production of goods or services. Distribution costs are the costs associated with the sale of products. They are divided into incremental and net distribution costs. The former include the costs of bringing the manufactured products to the direct consumer (storage, packaging, packaging, transportation of products), which increase the final cost of the goods; the second - the costs associated with changing the form of value in the process of buying and selling, converting it from commodity to monetary (wages of trade workers, advertising costs, etc.), which do not form a new value and are deducted from the value of the goods.
fixed costsTFC These are costs that do not change with changes in the volume of production. The presence of such costs is explained by the very existence of some production factors, so they take place even when the company does not produce anything. On the graph, fixed costs are depicted by a horizontal line parallel to the x-axis (Fig. 1). Fixed costs include the cost of salaries of management personnel, rent payments, insurance premiums, deductions for depreciation of buildings and equipment.
Rice. 1. Fixed, variable and general costs.
variable costsTVC are costs that vary with the volume of production. These include the cost of wages, the purchase of raw materials, fuel, auxiliary materials, payment for transport services, relevant social contributions, etc. Figure 1 shows that variable costs increase as output increases. However, one regularity can be traced here: at first, the growth of variable costs per unit of production growth proceeds at a slow pace (up to the fourth unit of production according to the schedule of Fig. 1), then they grow at an ever-increasing pace. This is where the law of diminishing returns comes into play.
The sum of fixed and variable costs at any given volume of production forms the total cost TC. The graph shows that in order to obtain a curve of total costs, the sum of fixed costs TFC must be added to the sum of variable costs TVC (Fig. 1).
An entrepreneur is interested not only in the total cost of goods or services produced by him, but also in average cost, i.e. firm's costs per unit of output. When determining the profitability or unprofitability of production, average costs are compared with the price.
Average costs are divided into average fixed, average variable and average total.
Average fixed costsA.F.C. - are calculated by dividing the total fixed costs by the number of products produced, i.e. AFC = TFC/Q. Since the value of fixed costs does not depend on the volume of production, the configuration of the AFC curve has a smooth downward character and indicates that with an increase in the volume of production, the amount of fixed costs falls on an ever-increasing number of units of output.
Rice. 2. Curves of average costs of the firm in the short run.
Average variable costsAVC - are calculated by dividing the total variable costs by the corresponding amount of output, i.e. AVC=TVC/Q. Figure 2 shows that average variable costs first decrease and then increase. This is also where the law of diminishing returns comes into play.
Average total costATC - are calculated by the formula ATC = TC/Q. In Figure 2, the average total cost curve is obtained by adding the average constant AFC and average variable costs AVC vertically. The ATC and AVC curves are U-shaped. Both curves, by virtue of the law of diminishing returns, bend upwards at sufficiently high volumes of production. With an increase in the number of employed workers, when constant factors are unchanged, labor productivity begins to fall, causing a corresponding increase in average costs.
The category of variable costs is very important for understanding the behavior of a firm. marginal costMC is the additional cost associated with the production of each subsequent unit of output. Therefore, MC can be found by subtracting two adjacent gross costs. They can also be calculated using the formula MC = TC/Q, where Q = 1. If fixed costs do not change, then marginal costs are always marginal variable costs.
Marginal cost shows the change in costs associated with a decrease or increase in the volume of production Q. Therefore, comparing MC with marginal revenue (revenue from the sale of an additional unit of output) is very important for determining the behavior of a firm in market conditions.
Rice. 3. Relationship between productivity and costs
Figure 3 shows that there is an inverse relationship between the dynamics of marginal product (marginal productivity) and marginal costs (as well as average product and average variable costs). As long as marginal (average) product rises, marginal (average variable) costs will fall and vice versa. At the points of maximum value of the marginal and average products, the value of marginal MC and average variable costs AVC will be minimal.
Consider the relationship between total TC, average AVC, and marginal MC costs. To do this, we supplement Fig. 2 with the marginal cost curve and combine it with Fig. 1 in one plane (Fig. 4). An analysis of the configuration of the curves allows us to draw the following conclusions that:
1) at the point a, where the marginal cost curve reaches its minimum, the total cost curve TC changes from convex to concave. This means that after the dot a with the same increments of the total product, the magnitude of changes in total costs will increase;
2) the marginal cost curve intersects the curves of average total and average variable costs at the points of their minimum values. If marginal cost is less than average total cost, the latter decrease (per unit of output). So in Figure 4a, the average total cost will fall as long as the marginal cost curve passes below the average total cost curve. Average total cost will rise where the marginal cost curve is above the average total cost curve. The same can be said for the marginal and average variable cost curves MC and AVC. As for the curve of average fixed costs AFC, then there is no such dependence, because the curves of marginal and average fixed costs are not related to each other;
3) Marginal cost is initially lower than both average total and average costs. However, due to the operation of the law of diminishing returns, they exceed both of them as output increases. It becomes obvious that further expansion of production, increasing only labor costs, is economically unprofitable.
Fig.4. The relationship of total, average and marginal production costs.
Changes in resource prices and production technologies lead to a shift in cost curves. So, an increase in fixed costs will lead to an upward shift in the FC curve, and since fixed costs AFC are integral part common, then the curve of the latter will also shift upward. As for the curves of variables and marginal costs, the growth of fixed costs will not affect them in any way. An increase in variable costs (for example, a rise in the cost of labor) will cause an upward shift in the curves of average variables, total and marginal costs, but will not affect the position of the fixed cost curve in any way.
To determine the total cost of production various volumes output and costs per unit of output, it is necessary to combine production data included in the law of diminishing returns with information on resource prices. As already noted, in the short term, some resources associated with technical equipment businesses remain unchanged. The number of other resources may vary. It follows that in the short run different kinds costs can be classified as either fixed or variable.
fixed costs. Fixed costs are those costs that do not change with changes in the volume of production. Fixed costs are associated with the very existence of the company's production equipment and must be paid even if the company does not produce anything. Fixed costs, as a rule, include payment of obligations under bonded loans, bank loans, rent payments, security of the enterprise, payment utilities(telephone, lighting, sewage), as well as time wages for employees of the enterprise.
variable costs. Variables are called such costs, the value of which varies depending on changes in the volume of production. These include the cost of raw materials, fuel, energy, transport services, on the most labor resources, etc. The amount of variable costs varies depending on the volume of production.
General costs is the sum of fixed and variable costs for any given volume of production.
General, fixed and variable costs will be shown on the graph (see Fig. 1).
At zero output, the total cost is equal to the firm's fixed costs. Then, for the production of each additional unit of output (from 1 to 10), the total cost changes by the same amount as the sum of variable costs.
The sum of variable costs varies from the origin, and the sum of fixed costs is added to the vertical dimension of the sum of variable costs each time to obtain a total cost curve.
The distinction between fixed and variable costs is significant. Variable costs are costs that can be managed quickly, their value can be changed over a short period of time by changing the volume of production. On the other hand, fixed costs are obviously out of the control of the firm's management. Such costs are mandatory and must be paid regardless of the volume of production.