Cost analysis in Production andMarket StructureCost analysis in Production:The production process came into being with the supply of factors of production or inputs used toget the final good or output.
The examples of the factors of production are the labor we will supply when you graduate, machines, raw materials such as pulp, power such as gas, electricity, machines, factory complex, research laboratory etc. In the supplyprocess, households first offer the factors of production they control to thefactor market. The factors are then transformed by the firms into the goodsthat consumers want. Production is the transformation of factors into useful goods.Concept of Firm:A firm is the economic institution or business organization thattransforms factors of production into consumer goods. It converts inputs tooutput or quantity supplied. They interacts with the market to determine thedemand and pricing and take steps to allocate the resources to get the maximumprofit.
The firms manages the factors of production and produce goods fromthese factors. The firm are also responsible to sell these good to theconsumers.Cost of Production:When a firm transforms a raw material into a useful good some costis spend to get the good. A firm spend some cost to produce any good. There aredifferent types of cost that a firm suffer. A firm always want to produce moregoods with a small cost. If the productions cost is high than the benefit thanthe firm tries to lower them.
Some cost of production are:1. Fixed Cost (FC)2. Variable cost(VC)3. Total Cost (TC)Fixed Cost:Fixed cost (FC) is the cost that whichdo not change or vary with the level of output.
This cost cannot be changed inthe time period of consideration. It does not depend upon the production orsales such as insurance, rent, property tax and interest rate. Fixed are in the short run not in the long run.Variable Cost:Variable cost (VC) is the cost thatchanges with the change in output. It vary with the level of activity. It dependon the output of production. It is the cost of raw material, labor and anyother overhead used in the production process.
Total Cost:Total cost (TC) is the sum of fixedcost (FC) and variable cost (VC). Fixed cost combine with the variable costmakes the total cost. It is plotted as the vertical summation of the horizontalline total fixed cost (TC) curve and the upward sloping total variable cost(TVC) curve.Total cost= Fixed Cost + VariableCostTC = FC + VCAverage Variable Cost:It is the total variable costdivided by the total units of output. It equals the total cost that can be varydivided by the quantity produced.AVC = TVC / QAverage Fixed Cost:It is the total fixed cost dividedby the total units of output. It equals the total cost that is fixed divided bythe quantity produced.
AFC = TFC / QAverage Cost (AC) or Average TotalCost (ATC):Average cost is the cost per unit ofoutput. It is found by dividing the total cost by the quantity of output. AC is the average summation of the averagefixed cost and average variable cost.AC or ATC = AFC+ AVCMarginalCost:It is theadditional cost of producing additional units of output.Total, Marginal and Average costAnalysis:The costanalysis result that if average fixed cost decreases continuously then moreoutput is produced. Since Total Fixed Costis constant so Average Fixed Cost must be decline as output increases.
The AverageVariable Cost and Average Total Cost first decreases and then increases and AverageTotal Cost are the addition of the Average Fixed Cost and Average Variable Cost.The curve of the total cost is represented by:Managers’ role in Cost ofProduction:Managersmust understand the all necessary cost of production. They must understand thetechnology and prices paid for production. They must know the differencebetween variable and fixed costs. They understand the difference betweenaverage costs (costs per unit of output) and (costs per unit of output) and marginalcosts (additional costs of producing additional units of output).Market Structure:Marketstructure is defined as the organizational and all other characteristics of amarket. There are few different market structuresthat characterize an economy.
Eaxh market structure has its own assumptions andcharacteristics that effect the decision making of firms and the profits.1. Perfect competition2. Monopolistic competition3. Oligopoly4. MonopolyIt is notnecessary that all of the above market structure really exits, some of them arejust theoretical based.
They will help us to understand the underlying economicprinciples. Perfect competition: It is characterized by different sellersand buyers most probably there are infinite numbers and sellers. The perfectcompetition happens when number of small firms competes against each other. Firmsin perfect competitive industry produce the maximum output by spending theminimal amount of cost to produce the more revenue. If the firms succeed to dothis, buyers and sellers have infinite alternatives to pursue.Monopolistic competition: Monopolistic competition is a market structurethat is combining the elements of perfect competition and monopoly. In thismarket structure, there are different competitive forms in a industry with thesimilar but at least slightly different product. Restaurants, for example, allserve food but of different types and in different locations.
Oligopoly: An oligopoly is similar to monopoly. Oligopolyis market structure with only a few firms.If theycollude, they reduce output and drive up profits the way a monopoly does.However, because of strong incentives to cheat on collusive agreements,oligopoly firms often end up competing against each other. While oligopolistsdo not have the same pricing power as monopolists, it is possible, without diligentgovernment regulation, which oligopolists will collude with one another to setprices in the same way a monopolist would.
Monopoly: A monopoly is opposite form of perfectcompetition. It is a market structure which has no competitors in its specific industry.There is only one producer of a specific product or service, and there is noreasonable substitute for the product or service. It reduces output to drive upprices and increase profits as they kept the price according to their wish asthere are no competitors for them.
Determinants of Market Structure:Ø The number of sellers operating in themarket.Ø The number of buyers in the market.Ø The nature of goods and services offeredby the firms.Ø The concentration ratio of the company,which shows the largest market shares held by the companies.Ø The entry and exit barriers in aparticular market.Ø The economies of scale, i.
e. how costefficient a firm is in producing the goods and services at a low cost. Also thesunk cost, the cost that has already been spent on the business operations.Ø The degree of vertical integration, i.e.
the combining of different stages of production and distribution, managed by asingle firm.Ø The level of product and servicedifferentiation, i.e. how the company’s offerings differ from the othercompany’s offerings.
Ø The customer turnover, i.e. the number ofcustomers willing to change their choice with respect to the goods and servicesat the time of adverse market conditions.Thus, thestructure of the market affects how firm price and supply their goods andservices, how they handle the exit and entry barriers, and how efficiently afirm carry out its business operations.