ACJC Firms and Decisions (1) Production Cost

© ACJC Economics Dept/JC1/2023/H2 Firms & Decisions (1) – Production & Costs 1 Section Content Page 1 Objectives of Firms 4 1.1 Primary Objective of Firms: Profit Maximization 5 1.2 Alternative Objectives of Firms 7 2 Decisions by Firms: Production and Cost Concepts 9 2.1 Production And Cost Concepts 9 3 Short-Run Cost of Production 10 3.1 Total Cost 10 3.2 Marginal Cost 11 3.3 Average Cost 11 4 Long-Run Cost of Production 13 4.1 Internal Economies and Diseconomies of Scale 13 4.2 Minimum Efficient Scale of Production 16 4.3 External Economies and Diseconomies of Scale 18 Learning Reflection & Annex 21 Reference Texts: 1. Case, Fair and Oster. Principles of Economics, Special Edition for ACJC, Pearson, 2013. Chapters 7-9 2. John Sloman. Economics, 8th Edition, Prentice Hall. Chapter 5. 3. Mankiw, Quah & Wilson. Principles of Economics, an Asian Edition, CENGAGE Learning. Chapter 13 ANGLO-CHINESE JUNIOR COLLEGE JC1 Economics H2 Firms and Decisions (1) PRODUCTION & COSTS

© ACJC Economics Dept/JC1/2023/H2 Firms & Decisions (1) – Production & Costs 2 WHAT IS THIS TOPIC ABOUT? In the free market economy, resources are allocated through the price mechanism, i.e. forces of demand and supply. The topic “Firms and How They Operate” examines issues related to resource allocation and resource utilisation from the perspective of firms. This topic gives you a better understanding of what decisions lie behind the supply curve in a market . This topic is divided into two main sections: (1) Production & Costs (2) Market Structure Firms allocate resources to produce goods and services, with the aim of making profit. Profit is the difference between revenue earned from the sale of the goods and the cost incurred in producing the goods. i.e. Profit = Total Revenue – Total Cost Section (1), Production & Costs, begins with the examination of production behaviour of firms since firms are primarily the agent that is responsible for transforming input s (i.e. resources) into output s (i.e. goods and services) for consumers. From production behaviour, we will go on to determine how cost varies when firms decide to adjust its output in the short run and in the long run. This topic also examines issues pertaining to firms such as mergers, outsourcing and off-shoring. In Section (2), Market Structure, we then examine the concept of revenue (what firms get when they sell an output), and highlight the difference between average revenue and marginal revenue of firms in perfectly competitive markets as well as markets with imperfect c ompetition. With the knowledge of cost and revenue, we can derive the firm’s profit. This section then examines what is meant by “profit” and the different types of profit. LEARNING OUTCOMES Enduring Understanding:  Profit is the difference between total revenue and total cost, with Economic profit taking Opportunity Cost into account  In the short run, the firm incurs both fixed costs and variable costs  In the long run, the firm incurs only variable costs  Total Revenue is the product of price per quantity unit and quantity sold: TR = P x Q  Internal economies and diseconomies of scale can affect the firm’s average cost Essential Question: What influences the quantity of output a firm decides to produce?

© ACJC Economics Dept/JC1/2023/H2 Firms & Decisions (1) – Production & Costs 3 Recall: 1. What is the central economic problem? 2. What is the firm’s main objective when deciding how to allocate resources? 3. Which economic principle do firms use to decide on the quantity to produce? This article is to be read and following the questions answered before your Economics lecture. Article (Pre-Lecture Reading): Are your sports shoes worth what you paid for them? The former National Basketball Association (NBA) star Stephon Marbury thinks shoe companies and their celebrity endorsers are ripping you off. With sneaker costing upwards of £100, it's not hard to see why he feels this way. Marbury now believes the market is ready to welcome his branded sneaker line Starbury that costs less than £10. Many activities go into creating a product from the design and manufacturing to the shipping, branding and retailing. These form part of the value chain, and thus the cost of a shoe. Often the physical assembly is done in low lab our-cost locations like China. However, this is only a small piece of the chain and not much of a cost for the company. Rather, shoes sold in the US actually get 70% of their value from work done in the US. This includes design, choosing the materials, hi ring sponsors, spending on advertising and retail. Customers want to make sure that when they buy shoes they have a guarantee of quality from the brand, and that has a price tag. More shoemakers are turning to high-quality materials such as kangaroo leather or mirror finishes that change colour which adds to the cost. 3 - D printing is also becoming popular as a way to produce the soles of trainers. The materials are getting better and that means the material costs go up, so prices increase. Arguably the most expensive piece of the value chain is building the brand. Footwear companies have to spend money to make their shoes desirable, cool and fashionable. And the field is becoming more competitive as athlete endorsers are increasingly being joined by other trendsetters like artists, musicians and graffiti artists. Companies spend a lot to get celebrity endorsers like Kanye West or Michael Jordan, as consumers are far more likely to pay a lot for shoes worn by their idols. The design of the shoe is also a large part of its value. Brands that work with endorsers typically ask for their input on the look and performance of the shoe. Once the shoe solves a problem like arch support, increased speed or more slip resistance, companies have to protect their plans through patents. Billions of pounds are spent by apparel companies each year to protect against counterfeits. That cost eventually gets tied into the price of a pair of shoes. SLS Lesson: “Overview”

© ACJC Economics Dept/JC1/2023/H2 Firms & Decisions (1) – Production & Costs 4 If Marbury is serious about getting his £10 shoes to shops he will have to figure out ways to radically limit costs. At least as a star himself he won't need to hire celebrity endorsers. And he has already proved that using social media is a quick and low-cost way of marketing. Zoe Thomas, BBC business reporter, 2 December 2015 Questions: (to be attempted before first lecture) 1) Why does Marbury want to start his own line of sneakers? (Hint: what might be his objective(s)?) 2) What are some costs that he should consider before starting and operating Starbury? (Hint: consider the cost incurred for production and possible opportunity cost) 3) What are some difficulties he might face that could prevent him from reaching his objective(s)? (Hint: consider what are some possible constraints) 1. OBJECTIVES OF FIRMS A firm is a business unit that combines units of factors of production (inputs) to produce goods and services (outputs). INPUT S OUTPUT INPUT S INPUT S INPUT S SLS Lesson: “Objectives of Firms”

© ACJC Economics Dept/JC1/2023/H2 Firms & Decisions (1) – Production & Costs 5 1.1 Primary Objective of Firms: Profit- maximisation  Profit is the difference between Total Revenue (TR) and Total Cost (TC). Firms can increase profit by either raising total revenue or reducing total cost.  A primary assumption in economics is that all firms aim to maximise profit, or minimise loss if they are experiencing losses.  By the marginal principle, total profit will be maximised at the output level where Marginal Revenue = Marginal Cost. This output level is termed the firm’s equilibrium o