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Concepts Behind Production Function And Cost Analysis

Production is the process of changing transformations of factors into goods and services. A productive organization enters into a contract of buying, modifying, selling goods and services within a specific period of time. The production function can be described as maximum output for a company or an economy with given inputs.

Q = f(K,L,M....)

Where Q = physical quantity of output

K, L, M = inputs like labor cost, materials cost, capital etc.

The values of Q, K, L, M can be positive or zero only.

There are two ways in which production function and cost analysis can be analyzed i.e. short run and long run production. These can be identified by fixed inputs and variable inputs. In short run there must be one fixed input and in long run involves all variable inputs.

There are two ways in which production function and cost analysis can be analyzed i.e. short run and long run production. These can be identified by fixed inputs and variable inputs. In short run there must be one fixed input and in long run involves all variable inputs. Managers operate projects in short run but they keep long run in vision as fixed inputs may not be appropriate as per market condition. While making cost analysis, they consider long run production.

Cost Function is the relationship between production and quality of output. There are various types of cost like opportunity cost (how to utilize resources in an activity), explicit cost(payment to an individual), implicit cost(value of using resource, which is not actually paid, is difficult to measure), fixed cost, variable cost, total cost, average cost, marginal cost.

Importance Of Production Function And Cost Analysis In Academic Curriculum

The study of economics is far beyond with demand and supply concept. It is the study of making decisions in difficult situations, how business works, how to take decisions when we have fewer resources, how to utilize our resources to get better profit, etc. Not only economic decisions. But it also teaches people to analyze and react to public policies imposed by the government. These can be learnt with the concept of the production function and cost analysis.

It also helps youngsters to learn how to run a business successfully. Knowledge of economics shows the path which points should be considered while analyzing cost, what kind of inputs and strategy they should apply to achieve better profit.

Difficulties Encountered By Students While Solving The Production Function And Cost Analysis

Analyzing production function and cost analysis involves different types of inputs, costs, the relationship between various inputs and costs. Not only these, we need to identify which one to include and exclude in different scenarios, as it varies as per industry need.

It is not a theoretical topic where we can mug up all the concepts, and can easily write in exam and pass. Because its importance it far beyond passing an exam. We need to understand what each concept mean and how it works.

Few Important Topics Covered Under Production Function And Cost Analysis

We have provided an overview of different kinds of inputs and costs above. Here we will discuss practical topics under production function and cost analysis.

Let's see below table for cost of earnings

 Output Fixed Cost Variable Cost Total Cost Average Fixed Cost Average Variable Cost Average Total Cost 4 50 48 98 12.5 12 24.5 5 50 50 100 10 10 20 7 50 55 105 7.14 7.85 14.99 11 50 60 110 4.54 5.45 9.99 15 50 75 125 3.33 5 8.33

From the above table, we can see fixed cost is 50 overall. Variable costs and outputs are changing.

Please find the formula below for calculating total cost (TC), average fixed cost (AFC), average variable cost (AVC) and average total cost (ATC).

TC = FC + VC

AFC = FC / Output

AVC = VC / Output

ATC = AFC + AVC

Use Cobb-Douglas method for calculating production function. Given constant = 60, parameter value for labor = 0.5, parameter value for capital = 0.5, input quantity of capital and labor are 3 and 5 respectively.

Cobb-Douglas Production Function is below:

Q = K0.5L0.5

Where input quantity K and L is capital and labor respectively

and Q is maximum quantity of output i.e. production function

Q = 60 (30.550.5)

= 60(15)0.5

= 232.37

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