Average and marginal production costs. Marginal cost and optimal output
The purpose of creating a business - opening a company, building a factory with the subsequent release of planned products - is to make a profit. But the increase in personal income requires considerable costs, not only moral, but also financial. All monetary expenditures aimed at the production of a good are called costs in economics. To work without loss, you need to know the optimal volume of goods / services and the amount of funds spent for their release. For this, average and marginal costs are calculated.
Average cost
With an increase in the volume of production, the costs dependent on it grow: raw materials, wages of the main workers, electricity, and others. They are called variables and have different dependence at different quantities release of goods/services. At the beginning of production, when the volume of goods produced is small, variable costs are significant. When increasing the number of products, the level of costs decreases, because there is an effect of economies of scale. However, there are costs incurred by the entrepreneur even with zero output of goods. Such costs are called fixed: public Utilities, rent, salaries of administrative staff.
Total costs are the totality of all costs for a specific amount of goods produced. But to understand the economic costs invested in the process of creating a unit of goods, it is customary to refer to average costs. That is, the quotient of total costs to output is equal to the value of average costs.
marginal cost
Knowing the value of funds spent on the implementation of one unit of the good, it cannot be argued that an increase in output by another 1 unit will be accompanied by an increase in total costs, in the amount equal to the value of average costs. For example, to produce 6 cupcakes, you need to invest 1200 rubles. It is immediately easy to calculate that the cost of one cupcake should be at least 200 rubles. This value is equal to the average cost. But this does not mean that the preparation of another baking will cost 200 rubles more. Therefore, to determine the optimal volume of production, it is necessary to know how much it will take to invest in order to increase output by one unit of the good.
Economists come to the aid of the firm's marginal cost, which helps to see the increase in total costs associated with the creation of an additional unit of goods / services.
Payment
MC - such a designation in the economy has marginal costs. They are equal to the private increase in total costs to the increase in volume. Since the increase in total costs in the short run is caused by an increase in average variable costs, the formula can be: MC = ΔTC / Δvolume = Δaverage variable costs / Δvolume.
If the values of gross costs corresponding to each unit of output are known, then marginal costs are calculated as the difference between two neighboring values of total costs.
Relationship between marginal and average costs
Economic business decisions should be made after marginal analysis, which is based on marginal comparisons. That is, the comparison of alternative solutions and the determination of their effectiveness occur by evaluating the cost increment.
Average and marginal costs are interrelated, and a change in one relative to the other is the reason for adjusting output. For example, if marginal spending is less than average, then it makes sense to increase output. It is worth stopping the increase in output when marginal costs are above average.
The equilibrium will be the situation in which the marginal cost is equal to the minimum value of the average cost. That is, it makes no sense to further increase production, since additional costs will grow.
Schedule
The presented graph shows the costs of the company, where ATC, AFC, AVC are the average total, fixed and variable costs, respectively. The marginal cost curve is labeled MC. It has a convex shape to the x-axis and at the minimum points intersects the curves of average variables and total costs.
According to the behavior of average fixed costs (AFC) in the graph, it can be concluded that increasing the scale of production leads to their decrease, as mentioned earlier, there is an effect of economies of scale. The difference between ATC and AVC reflects the amount of fixed costs, it is constantly decreasing due to the approach of AFC to the x-axis.
Point P, characterizing a certain volume of output of goods, corresponds to the equilibrium state of the enterprise in the market. If you continue to increase the volume, then the costs will need to be covered by profits, as they will begin to increase sharply. Therefore, the firm should stop at the volume at point P.
marginal revenue
One approach to calculating production efficiency is to compare marginal costs with marginal revenue, which is equal to the increase in cash from each additional unit of goods sold. However, the expansion of production is not always associated with an increase in profits, because the dynamics of costs is not proportional to the volume and with an increase in supply, demand decreases and, accordingly, the price.
marginal cost firms are equal to the price of the good minus marginal revenue (MR). If marginal cost is below marginal revenue, then production can be expanded, otherwise it must be curtailed. Comparing the values of marginal cost and income, for each value of output, we can determine the points minimal cost and maximum profit.
Profit maximization
How to determine the optimal size of production, allowing to maximize profits? This can be done by comparing marginal revenue (MR) and marginal cost (MC).
Each new good produced adds marginal revenue to total revenue, but also increases total cost by marginal cost. Any unit of output whose marginal revenue exceeds its marginal cost should be produced because the firm earns more revenue from the sale of that unit than it adds to costs. Production is profitable as long as MR > MC, but as output increases, increasing marginal cost due to the law of diminishing returns will make production unprofitable, as it will begin to exceed marginal revenue.
Thus, if MR > MC, then production must be expanded if MR< МС, то его надо сокращать, а при MR = МС достигается равновесие фирмы (максимум прибыли).
Features when using the equality rule limit values:
- The condition MC = MR can be used to maximize profit in the case when the cost of the good is higher than the minimum value of the average variable costs. If the price is lower, the company does not achieve its goal.
- Under conditions of pure competition, when neither buyers nor sellers can influence the formation of the value of a good, marginal revenue is equivalent to the price of a unit of goods. This implies the equality: P = MC, in which marginal cost and marginal price are the same.
Graphical representation of a firm's equilibrium
Under pure competition, when price equals marginal revenue, the graph looks like this:
Marginal costs, the curve of which crosses the line parallel to the x-axis, characterizing the price of the good and marginal income, form a point showing the optimal sales volume.
In practice, there are moments when doing business when an entrepreneur must think not about maximizing profits, but minimizing losses. This happens when the price of a good decreases. Stop production best way out because fixed costs have to be paid. If the price is less than the minimum value of the gross average expenditures, but exceeds the value of the average variables, then the decision should be based on the output of goods in the volume obtained by crossing the marginal values (income and costs).
If the price of a product in a purely competitive market falls below the firm's variable costs, then management must take the responsible step of temporarily stopping the sale of the goods until the value of the identical good rises in the next period. This will be the impetus for an increase in demand due to a decrease in supply. An example is agricultural firms that sell products in the autumn-winter period, and not immediately after harvest.
Costs in the long run
The time interval during which changes in the production capacity of the enterprise can occur is called the long-term period. The firm's strategy should include future cost analysis. In the long run, long-run average and marginal costs are also considered.
With the expansion of production capacity, there is a decrease in average costs and an increase in volumes up to a certain point, then the cost per unit of output begins to grow. This phenomenon is called the scale effect.
The long-run marginal spending of an enterprise shows the change in all costs due to an increase in output. Curves of average and marginal costs in time correlate to each other similarly to the short-term period. The main strategy in the long run is the same - this is the definition of production volumes by means of the equality MC = MR.
Needed to produce each additional unit of output. Marginal cost expresses the amount by which the costs of the enterprise will increase if production increases by the last additional unit of output, or the money that it will save if production decreases by one unit. Each volume of production has a specific marginal cost.
Marginal cost is the incremental cost that results from an increase in activity. This is the addition to total cost per unit increment if the change is discrete, or the addition to total cost per unit increment if the change is continuous.
Marginal cost can be short run, where only some of the inputs used can be changed, or long run, where all inputs can be adjusted.
Marginal private cost is the marginal cost incurred by an individual or firm making decisions to scale up, excluding any external costs; marginal social costs include external costs as well as private costs incurred by the decision maker.
In short-term planning, marginal cost is used to select the best option investment project.
The change in marginal cost depending on the change in the quantity of goods produced can be represented on the graph.
If the value of fixed costs does not change depending on the volume of production, then the marginal cost of MC is equal to the marginal variable cost. The marginal cost curve initially slopes down, reflecting increasing returns on input variable factors, i.e. costs rise at a slower rate than output. Then, however, the curve rises sharply, which indicates a decrease in returns, i.e. costs rise faster than output. Marginal cost and marginal revenue allow a firm to determine the scale of production at which it can maximize profits.
Marginal costs are also called weighted average (incremental) costs (incremental cost) or differential costs (differential cost).
Determining marginal cost is important for deciding whether to change output. In most manufacturing companies, marginal cost decreases as output increases due to , which includes factors such as bulk discounts on raw materials, specialization of labor, and more efficient use of equipment.
At a certain point, however, one has to deal with rising costs with further increases in volume, when marginal cost also begins to rise. Rising costs with further increases in production include factors such as more intense managerial control over a larger number of workers, more high costs on materials due to the depletion of local suppliers' resources and an overall less efficient investment.
The marginal cost curve is typically U-shaped, as shown in the graph. The company operates at the optimum level of production when marginal cost is the same as average total cost per unit of output. Thus, if the efficiency of production is below the optimal level, then the increase in production will lead to the fact that marginal cost will be lower than the average total cost per unit of output.
When the efficiency of production exceeds some optimal level, this will lead to the fact that the marginal cost will be higher than the average total cost per unit of output. In other words, selling at a price above the marginal cost per unit will increase the producer even if the selling price does not cover the average total cost per unit. Marginal cost is thus the minimum price at which the sale alone can be made without increasing the producer's losses or reducing his profits.
look at abstracts similar to "Marginal Cost"
Introduction 3
Chapter I. Costs, their essence, structure and classification
Marginal cost 4
Chapter II. The role of costs in a firm's strategy 10
2.1 Costs of the firm in the short run 10
2.2 Costs of the firm in the long run 14
3 Cost minimization. Modern interpretations of the motivation of the firm 16
Conclusion 27
References 28
Introduction
Agricultural farms, factories, hairdressers, department stores, banks, insurance companies - all these are firms (or enterprises) engaged in entrepreneurial activities.
A firm is a legal unit of business activity; an economic link that realizes its own interests through the manufacture and sale of goods and services through the systematic combination of factors of production.
An enterprise is an economic link within which the combination of factors of production is carried out to create goods and services. If an enterprise has its own interests and is a legal entity, it is a firm. If not, then it is part of the firm.
When creating a company, it is important first of all to determine who will bear the risk and liability, i.e. who finances entrepreneurial activity, is the legal owner of the company.
The main motive for the activity of any company in market conditions is profit maximization (profit is the difference between the income and expenses of the company). This premise does not mean at all that only profit determines the behavior of the producer of a commodity. The real possibilities of realizing this strategic goal are in all cases limited by production costs and the demand for the company's products. In specific cases (gaining a place in the market, competition, etc.), a firm can go for a temporary decrease in profits and even losses. But a firm cannot exist for a long time without profit, because it will not stand in the competition. Since costs are the main limiter of profits and at the same time the main factor affecting the volume of supply, decision-making by the company's management is impossible without an analysis of the existing production costs and their magnitude in the future. This applies to the release of already mastered products and to the transition to new products.
How to achieve maximum profit? General principle The choice is as follows: the firm must use a production process that, at the same level of output, finished products would allow the use of the smallest number of input factors of production, i.e., would be the most efficient.
Since the firm incurs certain costs for the acquisition of input factors of production (hires workers, purchases raw materials and equipment, pays for land, etc.), the above choice condition can also be represented as follows: the firm must use a production process in which the same volume of finished products is provided with the lowest cost of input production factors.
The costs of acquiring inputs, or economic resources, are called production costs. So the most economical effective method production of any product is considered to be such, in which there is a minimization of production costs.
In this paper, the author will try to reflect what the costs of production are; what is the structure and their types; what is marginal cost; how cost analysis affects the decision-making of the company's management on the behavior of the company in the market and the volume of production; firm's costs in the short run; firm's costs in the long run; cost minimization: the choice of factors of production.
Chapter I. Costs, their essence, structure and classification.
marginal cost
From the standpoint of the labor theory of value, K. Marx in "Capital" considered costs as costs for wages, materials, fuel, depreciation of labor instruments, i.e., for the production of goods. To these, he added the costs of the wages of trade workers (wholesale and retail), the maintenance of retail premises, transport, etc. Marx called the first cost the cost of production, the second the cost of circulation. At the same time, he did not take into account the market situation "and a number of other circumstances. Marx proceeded from the fact that the cost of a commodity is formed by the costs of production and those distribution costs that represent a continuation of the production process in the sphere of circulation, for example, packaging, packing, etc.
Modern economic theory approaches the interpretation of costs in a completely different way. It comes from the rarity of the resources used and the possibility of their alternative use. An alternative use is understood, for example, as the possibility of producing building materials, furniture, paper, a number of chemical products. Therefore, when a company decides to produce a certain product, for example, wooden furniture, it thereby refuses to produce from wood, say, blocks for country houses. From this it is easy to conclude that the economic, or imputed, costs of a certain resource; used in this production are equal to its cost (value) in the most optimal way of its use for the production of goods.
Resource constraints mean you always have to choose, and choosing means giving up one for the other.
As a result, costs are understood as all expenses, or costs, for the production of a certain volume of output. Depending on the costs, the efficiency of production and its rational organization are determined.
Costs have a direct impact on the competitive offer, and therefore it is necessary to introduce their classification in order to understand what role different types of costs play in such a proposal 1.
First of all, external and internal costs are distinguished. The first ones are related to the fact that the company pays employees, fuel, components, i.e. everything that she does not produce herself to create this product. Depending on the specialization, the amount of external costs for the production of the same product varies. Thus, at assembly plants, the proportion of external costs is greater.
Internal costs: owner own enterprise or the store does not pay its own wages, does not receive rent for the building in which the store is located. If he invests cash in trade, he does not receive the interest that he would have if he put them in the bank. But the owner of this firm receives the so-called normal profit.
Otherwise, he will not do this business. The profit they receive
(normal) is a cost element. It is also customary to allocate net, or economic, profit, which is equal to the total revenue minus external and internal costs, including normal profit. Unlike economic profit, accounting profit is equal to total revenue minus external costs.
Short-term costs are the current costs of production, which are objectively due to the production process itself. With the growth of production at the same production capacity and methods of purchasing raw materials, variable costs will increase and fixed costs per unit of output will decrease.
Long-term costs are determined by the firm's strategy in the long run. The long run is a period of time long enough for the firm to change the quantities of all resources used, including the size of the firm. An increase in the size of the enterprise for some time entails a decrease in the cost of producing a unit of output 1.
Practice shows that the amount of costs depends on the volume of output. In this regard, there is a division of costs into dependent and independent of the magnitude of production. Fixed costs do not depend on the volume of output, they exist even when no product is produced, or, as is often said, they exist even at zero output 2. They are determined by the fact that the cost of the company's equipment must be paid even if the enterprise stops . Fixed costs include payment for bonded loans, rent payments, part of deductions for depreciation of buildings and structures, insurance premiums, some of which are mandatory, as well as salaries for top management personnel and specialists of the company, payment for security, etc.
Variable costs depend on the volume of products produced, but this dependence has a different character for different quantities of products. Indeed, at the first stage, when the volume of production is small, such costs are significant. In the future, as the volume of production increases, the level of costs decreases, since the factor of economies of scale of production begins to operate. Finally, when the law of diminishing returns comes into play, variable costs begin to overtake production growth 3 . They consist of the cost of raw materials, materials, energy, wages to employees, transport, etc.
The sum of fixed and variable costs is gross costs.
Since they contain fixed costs, they always exist. It is also obvious that gross costs, including variable costs as the second term, increase simultaneously with the growth of the latter. For production management, it is important to know the value of costs per unit of output.
Based on these concepts, we can introduce the concept of the corresponding average costs, which are obtained by dividing the gross costs by the amount of output produced. The average fixed and variable costs are calculated in the same way.
Variable costs grow rapidly at first, then more slowly as the scale of production increases, and then grow faster as profitability decreases. Average costs initially fall, but after reaching a certain point, they begin to rise rapidly. Various methods are used to calculate costs and evaluate the production activities of enterprises in the West and in our country. In our economy, methods based on the category of cost, including the total costs of production and sale of products, have been widely used. To calculate the cost, both in our country and in the West, they classify costs into direct and indirect.
Direct production costs are those costs of production that are borne directly by the manufacturer. In economic theory, they are called cost. In enterprises where there is hiring of labor, they include the following elements: a) raw materials, basic and auxiliary materials, b) fuel and energy, c) depreciation, d) wages and social security contributions, e) other costs.
The indirect costs of production are borne by the state, which embodies society as a whole. These are the costs of education, medicine, sports (funded by the state), the maintenance of the army and law enforcement agencies, management, etc. As a rule, these costs ensure the reproduction of the labor force at a qualitatively new basis and create conditions for the normal functioning of production. The main source of repayment of these costs is the surplus product withdrawn by the state in the form of taxes and obligatory payments. Therefore, prices for goods and services are based not on prime cost, but on value, i.e. social costs of production 1.
On the basis of the previously introduced concepts of costs, or costs, it is possible to form the concept of value added, which is an important indicator of the efficiency of production and sales of products. The amount of value added is obtained by subtracting the variable costs from the total income, or revenue, of the enterprise. In other words, it consists of fixed costs and net income.
Since the purpose of the functioning of the firm is to maximize profits, the subject of calculations is the volume of production, which, in turn, necessitates the use of the marginal cost category.
Marginal cost is the cost of producing each additional unit of output relative to actual or estimated output2.
Marginal cost is the incremental cost, or expense, required to produce the next, additional unit of output. Therefore, marginal costs, or costs, can be found by subtracting two adjacent gross costs. Marginal cost is similar in form to the marginal utility of a good. Let us dwell in more detail on the analysis of the marginal concepts associated with production, namely the concept of the marginal physical product and the concept of marginal cost directly related to it.
Marginal physical product is defined as the increase in output expressed in terms of physical units, which is produced by each additional unit of variable costs of a certain kind, when other costs remain unchanged. For example, by increasing labor costs while maintaining energy and raw material costs, additional output can be produced. Since economic calculations and decisions are made in terms of money, the concept of marginal cost is more preferable.
Marginal cost is the additional cost required to increase output by one unit. It should be noted that when they talk about the marginal physical product, they use the term "costs", and the increase in output is measured in natural, physical units (pieces, meters, tons, etc.). Costs are always expressed in monetary units.
What are the advantages of marginal analysis, associated with the use of marginal concepts, in the economic study of production costs or costs?
To answer this question, it must be borne in mind that such an analysis, firstly, denies the approach to decision-making in terms of "all or nothing", secondly, does not take into account "sunk costs" and, thirdly, it, although it takes average costs into account, it is ultimately based on marginal or incremental costs.
Indeed, when making economic decisions we are talking not about the rejection of other costs or expenses in favor of a single one, but about their comparison and comparative assessment. As a result, it often makes sense to replace, for example, the costs of more expensive resources with relatively cheap ones. Such a comparison can best be made using marginal analysis.
The situation with "irreversible costs" is somewhat more complicated. If you bought, for example, boots and they do not fit you in size, style and other properties, then you are forced to sell them for a lower price. The difference between the initial purchase and the subsequent sale price is referred to in economics as a sunk cost. These costs are losses and are not taken into account when making future-oriented economic decisions. Indeed, they characterize missed opportunities associated with an ill-conceived decision taken earlier. Such decisions are encountered much more often than people think. This is especially true for decisions when priority is given not to economic, but to political, national and other factors, for example, when a plant is being built in a national republic, where there are no raw materials and qualified personnel necessary for production, sales markets are distant, etc. In the end everything
"irreversible costs" are carried out at the expense of investors, whether it be a joint-stock company or taxpayers of the state.
Finally, marginal cost must be distinguished from average cost, which is defined as the quotient of total costs on the number of products. It is obvious that an enterprise cannot sell its products below average costs, or costs, for in this case it will inevitably go bankrupt. Therefore, average costs are an important indicator of its performance.
There is a certain relationship between average and marginal costs, according to which marginal costs must equal average costs in the case when the value of the latter reaches its minimum. Therefore, the activity of the enterprise can best be judged precisely by marginal costs or costs. That is why any economic decisions should be based on marginal or marginal analysis.
We can compare the effectiveness or inefficiency of alternative economic solutions on the basis of marginal comparisons, and such comparisons involve an assessment of what increments we are dealing with in the limit, on the border of changes in the corresponding values. Whether such increments of costs will be positive or negative, what will be the marginal or additional costs - all this basically determines the nature of the economic decision.
In its form, marginal costs are in many ways similar to marginal utility, because in the latter case we are also talking about additional additional utility of the product. From this point of view, all limiting concepts can be considered as differential concepts, since they deal with the increment of the corresponding quantities (utility, costs, etc.). However, in terms of specific content, they differ significantly, which can be clearly seen by comparing the curves of marginal cost and marginal utility. To do this, we construct a graph of marginal costs (Fig. 1) and compare it with the graph of marginal utility.
General costs
MS Demand C
marginal marginal cost
Item Quantity Item Quantity
Rice. 1a Fig. 1b
Chart 1 also shows, on a more convenient scale, the marginal cost curve that the constant demand curve crosses at point C.
It is not difficult to understand that the marginal cost curve is at the same time the competitive supply curve of an enterprise or firm. At point C, where this curve intersects the horizontal demand curve, marginal cost is exactly equal to the established equilibrium price. This means that if an enterprise can sell any quantity of its output at the market price, then it is its marginal cost that will be equal to this price. This condition can be expressed as a requirement to achieve equilibrium of the enterprise on the demand curve, i.e. MC=P, where P is price and MC is marginal cost.
Thus, the concept of marginal cost enables the company to predict the competitive offer of its products. To do this, it is necessary to construct a marginal cost curve and identify it with the supply curve. Then we can expect that the maximum profit will be achieved at the point of intersection of the supply curve with the line of the equilibrium market price.
But not only this conclusion can be drawn from the analysis of the marginal cost curve. If you look at the matter not from the point of view of an individual entrepreneur, but more broadly, taking into account the interests of the welfare of society, then it is easy to see that the economy will seek the greatest return from limited resources, technical capabilities and knowledge only when the prices of commodities are set according to marginal cost.
We can also say that the optimal organization of the economy involves reducing to a minimum the average cost of production. It is clear that as long as the revenue from the last additional unit sold exceeds its marginal cost, the profit of the enterprise will increase.
It will reach its maximum value precisely at the point of intersection of the supply curve and equilibrium demand. After it, marginal cost will rise, and the price will remain unchanged, which will force the company to stop production.
An efficient economy involves the optimal distribution of the limited resources available to society to meet the needs for goods of the required range and quality. To achieve the well-being of society and the growth of the efficiency of its economy, a certain correspondence between marginal utility and marginal costs in each branch of production is necessary. This means that if the marginal utility, for example, of a 100 g serving of cottage cheese is 4 times less than the same serving of cheese, then the market price corresponding to its marginal cost should be four times less. From this, the close relationship between the concepts of marginal utility and marginal cost becomes clear: if marginal utility characterizes the demand for a product, then marginal cost characterizes its supply, and therefore, in order to balance supply and demand, it is necessary to achieve a correspondence between marginal costs and utility. However, it should be remembered that such ratios exist only within the framework of perfect competition, when the benefit of one enterprise, as V. Pareto established, is achieved at the expense of the deterioration of the affairs of another enterprise 1.
Efficient allocation of resources requires equalization of marginal cost with the prices of goods, and therefore the market directs resources to where costs are lower than in other enterprises.
Chapter II. The role of costs in the firm's strategy
Above, we encountered the important fact that the value of the costs of a firm or industry depends on the amount of resources used.
Changing the amount of resources used in some cases can be carried out relatively quickly, in others it takes a significant amount of time.
So, in the presence of unemployment and the presence of workers of appropriate qualifications in the labor market, it is easy to increase the volume of production due to the mass of living labor. A similar situation may occur when additional resources of raw materials or energy are used. Naturally, in this case it is necessary to take into account the specifics of production. Thus, an increase in the volume of production (for example, in the production of furniture according to individual orders) can be easily obtained by attracting additional workers. But a completely different situation develops when it is necessary to expand production capacities, areas of industrial premises, etc. Here, the required time is measured in months, and sometimes, say, in heavy engineering or metallurgy, in years.
It follows from this that when economic analysis it is necessary to distinguish between short-term and long-term periods. From an economic point of view, the essence of the difference between them lies in the possibility of changing production capacities. In the short term, it is not possible to bring new production capacities into operation, but it is possible to increase the degree of their utilization. Within the long-term period, it is possible to expand the production capacity.
Of course, the scope of these periods for different industries are different. The division into two periods is of great importance in determining the strategy and tactics of the firm in maximizing profits.
2.1 Costs of the firm in the short run
In this case, the production capacity of the company remains unchanged and the performance is determined by the growth of equipment utilization.
Fixed costs per unit of output, i.e., specific fixed costs, fall as output increases, since their absolute value is unchanged. In practice, their value may undergo slight changes. Thus, with the growth of production, security costs may increase due to the increased risk of theft. The dependence of variable costs in the function of production growth is more complicated. At the first stage, there is a decrease in specific variable costs: the effect of the scale effect, the increase in production volume.
Starting from a certain point, the larger and larger size of the enterprise leads to an increase in average total costs. Such a situation in economic theory is called positive and negative effects of the growth of scale of production, or economies of scale 1. The positive effect of scale is determined by factors acting in the direction of reducing average production costs: specialization of labor, specialization of the managerial staff, production of by-products, etc.
The negative economies of scale are associated with certain managerial difficulties that arise when trying to effectively coordinate and control the activities of a firm that has become a large-scale manufacturer.
Since production costs are one of the factors determining the amount of profit, reducing them is the most important task of any manufacturer. The main factors in reducing production costs are: the growth of labor productivity based on the use of scientific and technological progress, since with the growth of labor productivity, gross costs are distributed over a larger number of units of production, which reduces the cost of each of them; resource savings, which is achieved through changes in production technology, the introduction of interchangeable but cheaper materials, energy sources, etc.; compliance with the production regime, technological discipline, schedules, standards, etc.; other factors.
But then the unit variable costs begin to rise: the effect of diminishing returns takes over the scale effect. So, at a machine-building enterprise, work in three full shifts can lead to a decrease in the output of equipment, since the release of products on the third shift excludes the possibility of preventive maintenance, which will inevitably lead to downtime of machines and equipment.
For the company's activities, two points are decisive. First, as long as marginal cost is less than average cost, there is a decrease in average cost, which will continue until the last increase in marginal cost is less than all previous ones. When the market price falls, enterprises will begin to leave the industry (or this production). You can continue to work if the transition to the production of other products is associated with a high risk or an analysis of the prospects allows you to conclude that there is an opportunity in shortest time an increase in the price of products due to an increase in demand or a deterioration in the position of competitors.
The position of the firm is much worse if the selling price is equal only to unit variable costs. In this case, the sale of products does not allow to recover all the costs of its production. The management of the company has no choice but to stop the production of these products. At the same time, the option of declaring the company bankrupt is not excluded.
In the domestic practice of accounting at the vast majority of enterprises and firms, instead of the category "costs", the category "cost" is used, which in its content differs significantly from the category "costs". The concept of cost was given above. Currently, the transition of domestic accounting to the Western system has begun. This transition is inextricably linked with the transition to national accounting according to the UN system. Joint firms have been the most successful in this area.
The cost price is the total cost of production and sale of products. They can be calculated both in terms of actual costs and in terms of normative ones. Western firms also have standards for expenses, but they are calculated within each individual firm and are a trade secret. In Russia, at state-owned enterprises, the standards are industry-specific and do not represent any commercial secret. Unfortunately, in many cases, the standards do not play the role of an incentive to reduce the costs of enterprises for the production of products. Practice allows us to assert that they are often industry average. Enterprises always have the opportunity to prove that they work in special conditions and industry standards are unacceptable for them 1.
Why does one firm manage to minimize costs while another fails, even if it has a significantly higher sales volume? And in general, what does
“Minimize costs? If for one entrepreneur they amount to 1 thousand rubles, and for another - 10 thousand rubles, then in which production is the cost minimized? To answer this question, we must estimate the costs of both entrepreneurs per unit of finished product: costs are minimized where fewer inputs are spent in the production process per unit of finished product. Since, as we noted above, production costs depend on effective use economic resources, then the cost of production per unit of output will ultimately be determined by the price of resources and vary depending on the volume of production.
In carrying out his activities, an entrepreneur has to make a lot of decisions: how much to buy raw materials, how many workers to hire, what technological process to choose, etc. All these decisions can be roughly grouped into three groups: 1) how to best organize production at existing production facilities; 2) what new production facilities and technological processes choose taking into account the achieved level of development of science and technology; 3) how best to adapt to the discoveries and inventions that make a breakthrough in technical progress.
The period of time during which the company solves the first group of issues is called the short-term period in economic science, the second - long-term, the third - very long-term. The use of these terms should not be associated with a specific period of time. In a number of industries, let's say energy, the short-term period lasts many years, in another, for example, aerospace, the long-term period may take only a few years. The "length" of the period is determined only by the relevant group of issues to be resolved.
The behavior of the company is fundamentally different depending on which of the listed periods it operates. In the short run, the individual factors of production do not change; they are called permanent
(fixed) factors. These, as a rule, include such resources as industrial buildings, machines, equipment. However, it can also be land, the services of managers and qualified personnel. Economic resources that change during the production process are considered variable factors. In the long run, all input factors of production may change, but the basic technologies remain unchanged. In the course of a very long period, the underlying technologies may also change.
Let us dwell on the activities of the company in the short run. Let us introduce a number of concepts that we will need in the analysis of the firm's activities.
Total, average and marginal product. Let's consider some conditional firm.
For simplicity, we will assume that production is established using only two factors: capital and labor. At the same time, capital is a constant resource, and labor is a variable one.
Let's define the introduced concepts: - total (total) product - the total amount of products produced for a given amount of time
(month). If the value of all but one of the inputs of production remains unchanged, then the total product will rise or fall as the quantity of the variable input increases or decreases; average product - the amount of production per unit of the variable factor - labor. marginal product - a change in the value of the total product due to the introduction into production of one additional unit of any variable factor.
Thus, the operation of the law of diminishing returns is inevitable: if in the process of production all the input factors of production remain unchanged, and the amount of the variable factor increases, then the situation will invariably come when each additional unit of the variable factor will add a smaller and smaller amount to the total product. This is tantamount to saying that, under the same conditions, a moment will inevitably come when the values of marginal product begin to decrease.
The initial growth of the total product is explained by the effect of the division of labor and the possibility of improving the organization of the production of goods.
However, if all other factors remain unchanged, then a moment will surely come when the reserves of the division of labor will be exhausted, and each additional unit of the variable factor will begin to bring an ever smaller addition to the total product. Strictly speaking, a situation is possible when the marginal product becomes equal to zero (i.e., the additional worker does not add anything to the total product) and even negative (which means that the new worker has already simply interfered with production and the total product is reduced).
By definition, the value of the average product is equal to the total product.
Consider now the costs of the firm in the short run. In this case, we will proceed from the assumption that the firm cannot influence the price of the resources it uses. Knowing the price of resources and the value of the total product, average product and marginal product, we can calculate the corresponding costs. Total costs - the total costs of the firm associated with the release of a given volume of finished products. Total costs are divided into two parts: total fixed costs and total variable costs. Total fixed costs do not change with an increase or decrease in output.
Moreover, they take place even when the finished product is not produced at all. In many respects, the presence of general fixed costs is explained by the use of fixed factors of production in the short run. Such costs include interest on a loan taken for the purchase of equipment, depreciation, insurance premiums, rent
- they must be paid regardless of the volume of finished products.
Total variable costs change with the increase in output: the firm hires more workers for this, buys more raw materials, increases electricity costs, etc. Since the variable factor is labor, the wages of workers will be the total variable costs of the firm.
Average cost is the firm's cost per unit of output.
In magnitude, they are equal to the total cost of producing a certain amount of output divided by the amount of output produced. Average costs can also be subdivided into average fixed and average variable costs. It should be borne in mind that with the growth of output, average variable costs can either increase or decrease; as for the average fixed costs, they are constantly decreasing with the growth of output.
Marginal cost is the increase in total costs associated with an increase in the output of finished goods by one additional unit. Since fixed costs do not change, fixed marginal costs are always zero. Therefore marginal cost is always marginal variable cost.
Average variable costs reach their lowest values when the average product is maximum. Therefore, the law of the inevitability of a decrease in marginal product can be interpreted as the law of an inevitable increase in marginal cost.
This means, firstly, that at low volumes of production, the value of the average product grows (correspondingly, the average total costs decrease) and, secondly, that from a certain moment the value of the average product begins to decrease so rapidly that the increase in average variable costs exceeds the decrease in average constant costs. costs1.
2.2 Costs of the firm in the long run
Consider how the company's strategy should be built in the long run. Recall that if in the short run changes in the production apparatus of the firm cannot be made, then in the long run both the volume of equipment and production infrastructure and their structure can change. The firm can install new production facilities, build new workshops; to expand transport arteries, etc. The opposite option is also possible - a decrease in production capacities. New firms can enter the industry, which will change the competitive situation. We will consider only changes in individual firms.
Since production capacities change in the long run and, accordingly, the number of employees, we can conclude that all costs in the long run act as variables. When the firm expands, there will be a change in gross costs. As in the short term, they will first decrease due to economies of scale, the concept of which was disclosed above. Then, when the effect of the effect of scale of production is exhausted, they will reach a minimum. Then the process of increasing gross costs 2 will begin.
When analyzing the behavior of the firm in the short run, we proceeded from the assumption that, wanting to achieve a certain level of output of finished goods, the firm can change only one factor of production, while the rest remain unchanged. In the long run, the firm can solve the problem of producing one or another volume of output by changing all the input factors of production. Such decisions impose a great responsibility on the entrepreneur, since a mistake and the acquisition of low-performance machines and equipment is fraught with ruin. In addition, long-term decisions should take into account the future cost of resources, possible market conditions, and the state of the industry as a whole.
As we have already noted, any firm seeking to maximize profits must organize production in such a way that the cost per unit of output is minimal. This means that the long-term decision to be made should be guided by the task of minimizing costs. We will, as in the case of the short run, assume that the prices of economic resources remain unchanged. In addition, for simplicity, we will assume that only two factors are used in production - labor and capital, and in the long run both of them are variables. Let's make one more assumption: first we fix a certain volume of production and try to find the optimal ratio of labor and capital for a given volume of production. When we understand the algorithm for optimizing the use of two factors for a certain volume of production, we can find the principle of minimizing costs for any volume of output.
So, a certain volume of products is produced at a given ratio of labor and capital. Our task is to figure out how to replace one factor of production with another in order to minimize the cost per unit of output. The firm will replace labor with capital (or vice versa) until the value of the marginal product of labor per one ruble spent on acquiring this factor becomes equal to the ratio of the marginal product of capital to the price of a unit of capital.
It follows that if the entrepreneur gives up two units of labor, he will reduce production and free up money. On them he can hire one additional unit of capital, which will compensate for the loss of production.
This means that by replacing two units of labor with one unit of capital (for a given volume of output), the firm can reduce total costs.
However, it should be borne in mind that a decrease in the volume of labor will invariably lead to an increase in the marginal product of labor (in accordance with the law of diminishing returns), and an increase in the amount of capital used, on the contrary, will cause a fall.
In the long run, at a given output, the firm achieves an equilibrium in the use of input factors of production and minimizes costs, when any replacement of one factor by another does not lead to a decrease in unit costs.
If, say, the relative price of labor increases, then this will force the firm to use less of the more expensive resource, labor (which will cause an increase in marginal product and more of the relatively cheap resource, capital (thus reducing marginal product).
If prices for resources are given and remain unchanged, then for each volume of production we can find the optimal, in terms of minimizing average costs, combination of labor and capital.
With a further increase in output, average costs begin to increase again. If we assume that the prices of economic resources remain unchanged, then the initial decrease in average costs in the long run is explained by the fact that with the expansion of production, the growth rate of finished products begins to outstrip the growth rate of costs for input production factors. This is due to the so-called
“the effect of economies of scale. Its essence lies in the fact that at the initial stage, an increase in the number of input factors of production makes it possible to increase the possibility of specialization of production and the distribution of labor. A decrease in average costs can also be caused by the use of more productive equipment; a decrease in the number of employees.
However, further expansion of production will invariably lead to the need for additional management structures (heads of departments, shifts, workshops), increased costs for the administrative apparatus, it will be more difficult to manage production, and failures will become more frequent. This will cause an increase in production costs.
When planning activities for the future, the entrepreneur must assess the potential for expanding production. If he takes risks and increases the amount of capital, then at first he may face losses - the volume of production will decrease. But then, using the potential economies of scale in the next short run, the firm will achieve an increase in production while reducing average variable costs.
This is where the opportunity cost associated with entrepreneurial risk shows up: the entrepreneur who was afraid to take the risk and expand production missed out on an equal benefit. the product of the value of the resulting increase in production and the value of the decrease in average costs.
The entrepreneur should always take risks and expand production when he is sure that the potential for expansion effects can reduce average costs while increasing production. Any attempt by the firm to simultaneously increase production and reduce average costs will fail.
The opportunities for economies of scale will run out, and the entrepreneur who takes the risk of further expansion of production will fail 1.
2.3 Cost minimization. Modern interpretations of the motivation of the company
In the long run, if there is an increase in production capacity, each firm faces the problem of a new ratio of factors of production. The essence of this problem is to ensure a predetermined volume of production with minimal costs. Any firm strives to make such decisions that would provide it with the highest possible profit. The latter is understood as the difference between the total income of the firm and the opportunity costs of all input factors of production; profit maximization is achieved when the firm minimizes its costs; the behavior of the firm depends on the period in which it operates. In the short run, only input variable factors of production change, all others remain fixed. Acting in this period, the firm (taking into account the volume of fixed resources) will introduce additional units of the variable factor and expand production, seeking to achieve the minimum cost per unit of output. in the long run, all inputs change.
The entrepreneur should expand the volume of production while the effect of "economy of scale" works, that is, in the long run, the volume of output should correspond. minimum average cost curve in the long run.
Firms operate in industries with different market characteristics or, as they say, with a different market structure. Conventionally, four types of market structures can be distinguished, and although each firm seeks to maximize profits, the results that it achieves are different and are related to which of the four types the industry belongs to. This is, firstly, perfect competition, and secondly, absolute, or pure monopoly 2. Between these extremes, there are many options for organizing the market, which can be combined with the general concept of imperfect competition. Among markets of imperfect competition, in turn, there are two main types: oligopoly and monopolistic competition.
Perfect competition is typical for industries in which a large number of companies produce a standardized product. The share of the output of each individual firm in the total volume of industry production is extremely small, and the firm cannot influence the market price of products.
Since, under perfect competition, the price for an individual producer is given, the gross income of a firm in such a market is directly proportional to the growth in output.
The dynamics of the firm's costs under all conditions is associated with the law of diminishing marginal productivity of production factors. It underlies the fact that, starting from a certain level of production, gross costs grow faster than the volume of output and gross income.
The dynamics of gross income and production costs determines the movement of profits. The level of production at which gross costs equal gross income is called the tipping point.
The activity of the firm is economically justified at those volumes of production that lie between the turning points, since only in this case it receives a positive economic profit.
Under perfect competition, the long-run equilibrium of the firm is gradually established. It implies no economic profit for firms in an industry and is achieved when producers can only cover their costs, which include the average return on capital invested.
Producers can achieve this only at such a volume of production that provides them with a minimum cost per unit of output. If some firms operate at higher costs, they fail and leave the market.
Firms in monopolized industries can influence the price of output.
The gross income of a monopoly firm does not increase in proportion to the growth of manufactured and sold products.
The gross income of such a firm, obtained at different prices for a product, depends on the market demand curve for it. The general pattern is that with the growth of the volume of production, the income of the company first increases, and then decreases.
Insofar as the main objective firms - profit maximization, then the firm should bring the volume of production only to such a limit at which gross income grows at the same rate as costs. This level of production may be much lower than that at which maximum income is achieved.
Under conditions of pure monopoly, the access of new producers to the industry is difficult and the monopoly firm can receive economic excess profits for a long time.
In a perfectly competitive market, price equals marginal cost. If such a situation is typical for all industries, then the economy achieves the production of an optimal set of goods and an ideal distribution of resources, i.e., the optimal efficiency of the distribution of social resources is ensured.
In a monopoly, the price exceeds marginal costs, which indicates the inefficiency of this type of market structure in terms of the efficiency of distribution of economic resources. The volume of production of goods is underestimated in comparison with the social need for it.
Oligopoly - a situation where the market is controlled by several companies. When there is a formal agreement between firms concerning pricing or the division of the market, it is called a cartel, or a group monopoly. Such forms of oligopoly prevail when there is no explicit agreement between companies.
As in the conditions of pure monopoly, the excess profits of companies under oligopoly for a long time can be maintained by limiting the volume of output.
An industry is under conditions of monopolistic (differentiated) competition if many firms operate in it, but unlike the conditions of perfect competition, the industry's products are not standardized. Due to relatively easy access to industries with differentiated competition, firms in these industries cannot earn monopoly profits for long periods of time.
Oligopoly and monopolistic competition are united by the general concept of imperfect competition.
Now let's look at the above types of market structures in more detail.
1. Pure (perfect) competition
Characterized by a large number of competing sellers who offer standard, homogeneous products to many buyers.
The volume of production and supply by each individual producer is so insignificant that none of them can have a noticeable effect on the market price. The price of homogeneous products in such a market develops spontaneously under the influence of supply and demand. It is based on the social value of commodities, which is determined not by individual, but by socially necessary expenditures of labor for the production of a unit of output.
At a given price, the consumer does not care which seller to buy the product from. Due to the standardization of products, there is no basis for non-price competition, that is, competition based on differences in product quality, advertising or sales promotion.
Competitive market participants have equal access to information, i.e. all sellers have an idea about prices, production technology, and possible profits. In turn, buyers are aware of prices and their changes. In such a market, new firms are free to enter and existing firms are free to leave. There are no legislative, technological, financial or other serious obstacles for this. The limiter here is only the profit received. Each entrepreneur will produce goods up to the point where price and marginal cost do not equalize. Up to this point, he will exist in this industry, after it he leaves the industry, moving capital to one of them that brings the highest profit. This, in turn, means that resources under conditions of pure competition are distributed efficiently.
It should be noted that perfect competition in its purest form is a rather rare phenomenon. However, the study of this market model is of great analytical and practical importance and its purpose is to study demand from the point of view of a competitive seller, to understand how a competitive manufacturer adapts to the market price in the short term, to investigate the nature of long-term changes and adjustments in the industry, to evaluate the effectiveness of competitive industries with the point of view of society as a whole.
Agriculture most closely reflects the concept of perfect competition by definition, perfect competition is observed in those industries where many companies produce a homogeneous (standardized) product. Buyers are well aware of who is trying to sell their grain at the lowest price. Such a situation does not allow an individual firm to significantly influence the price by varying output. In fact, in such industries, the firm has no choice at what price to sell its product: it can only sell at the prevailing price. If a farmer tries to sell grain above the established price, he will not find buyers. It also makes no sense for him to sell cheaper, since he can sell all the grain at a higher price.
In addition, it is quite easy for new manufacturers to join such an industry, and for old ones to cease to exist. Many empirical calculations show that this condition is more important for the development of competition in the industry than a large number of companies in it. According to observations, situations are possible when, even with a small number of companies, the possibility of a quick breakthrough of new manufacturers into an established market extremely intensifies competition and does not allow old companies to set high prices.
The situation when an individual firm cannot influence the price, i.e., perceives it as given, means that the demand faced by this firm is perfectly elastic, so that an extremely small increase in price can lead to the complete disappearance of demand for the firm's products, and an extremely small drop in price - to an immense increase in demand. Note that the output of an individual firm is extremely small compared to the level of supply and demand in the industry, so that an increase or decrease in the output of an individual firm does not affect the price.
Since the individual producer cannot influence the price of the commodity, he is left to sell his output at the established market price. If the price of a ton of grain on the American market is $5 per bushel, then the income of an individual farm is $5 times the amount of grain sold. This means that for each additional unit of output, the farmer's gross income increases by $5.
Therefore, under perfect competition, the gross income of the farmer is directly proportional to the growth of output. With a production volume of, specifically, 31,600 bushels, the gross income of the farm would be $5 x 31
600 = $158,000
The costs of an agricultural farm change more "intricately".
Fixed costs do not depend on the volume of production. In our example, on a typical American grain farm, they are about 60 thousand dollars.
These are fixed costs, which, as noted above, include not only the cost of depreciation of buildings and equipment, not only the amount of interest payments on loans, but also the normal return on equity of the farm owner, as well as the cost of paying the services of a farm manager. .
To fixed costs are added variable costs, the volume of which is directly related to the volume of production. They include the costs of seeds, fertilizers, water supply, and the wages of hired workers. With a production volume of 31.6 thousand bushels, the total cost of the farm will be $140 thousand.
It should be noted that the growth rate of gross costs does not coincide with the growth rate of output, as was the case with gross income.
At first, costs grow more slowly than the volume of production, then about the same, and in the end they completely overtake it. Costs rise especially when the level of production begins to exceed 25 thousand bushels of grain. What is the matter here? Margin analysis comes to the rescue again.
Recall that marginal cost (PI) is equal to the increase in gross cost with an increase in output per unit. If it costs the farmer $115,000 to produce 25,000 bushels of grain and $120,000 to produce 26,000 bushels, then the marginal cost of the 26th thousand is $5,000. th thousand are already equal to 7 thousand dollars (127 - 120).
Economic studies have shown that at the initial stage of increasing production, marginal costs decrease, and then begin to increase. What is the reason for this marginal cost behavior? To understand this, let's introduce another important distinction: the capabilities of the firm over short and long periods of time.
A short period is a period of time during which a firm cannot change (increase or decrease) the quantity of all factors used in production. Thus, a firm cannot change the overall dimensions of its facilities, the number of machinery and equipment, and in the case of agriculture, the size of land. These are permanent factors of production. In an attempt to meet the growing demand, the company usually hires more workers and also purchases more raw materials.
Long period - a period of time during which the firm gets the opportunity to change the amount of all factors of production, i.e., they all become variables.
We consider the firm for a short period of time, when part of the factors of production is constant, and part is changing. It is this circumstance that causes marginal cost to increase over time. Assume that the only variable is labor costs. Let's introduce a new definition - the marginal physical product of the (variable) factor (PFPF), in this case, labor. PFPF is equal to the increase in the volume of output with a change in the amount of labor applied per unit. If 10 workers produce 20 pairs of shoes and 11 workers produce
23 pairs, then the marginal product of the 11th worker is 3 pairs (23 - 20). It is easy to calculate that if the inclusion of one worker gives 3 additional units of output, then for the production of one additional unit it is necessary to attract only a third of the labor costs (1/3) that were used above.
In general, the additional amount of labor required to produce an additional unit of output is equal to I/PFPF. Multiplying this figure by wages, we get the value of marginal cost, which, by definition, is equal to the increase in costs (in this case, wage costs, because labor is the only variable factor) required to produce an additional unit of output:
In our example, with a salary of 3000 rubles. per hour and marginal product - 3 pairs of shoes - the marginal cost of production of 1 pair is
1000 rub.
The formula clearly shows that the reason for the change in marginal cost is the change in the marginal physical product of the factor, and PI and
PFPF are moving in different directions. It is no coincidence that the period in which marginal cost falls is called the period of increasing productivity.
(increasing PFPF), and the one where marginal cost increases, a period of diminishing productivity (decreasing PFPF).
The principle according to which it is stated that if some factors are fixed, then over time more and more other, variable, factors are required to produce an additional unit of output, is called the law of diminishing marginal productivity.
It underlies the phenomenon that, starting from a certain level of production, gross costs grow faster than the volume of output.
Returning to the example of the American grain farm, we see the same process. However, the main role in it is played by limited reserves of land.
It is precisely the fact that land is limited and it is impossible to increase the area under crops to increase grain output, which forces the farmer to look for other ways: to use more fertilizers, water, hire more workers, i.e., use the available land more intensively. Eventually, total costs will rise so rapidly that they will outpace the growth in output.
As we have already said, the dynamics of gross costs (VI) and the dynamics of gross income (VD) determines the movement of profit (P): P = VD - VI. The level of production at which gross costs equal gross income is called the tipping point. The activity of the firm is economically justified only with those volumes of production that lie in the interval between the turning points, since only in this case it receives a positive profit. The firm achieves maximum profit when it produces such a volume of output at which gross income exceeds gross costs to the maximum extent.
In our example, we can see that a grain farm starts to earn positive profits only after its production reaches 18,000 bushels of grain. This is the low point of inflection for the farm.
Earnings turn negative again after production exceeds the upper tipping point of 40,000 bushels of grain. Staying between 18,000 and 40,000 bushels, the farm earns a positive profit, that is, its gross income exceeds its gross costs. However, the farm will be able to achieve maximum profit only if the volume of output reaches 31.6 thousand bushels. It is at this point that gross income ($158,000) exceeds gross costs ($140,000) to the maximum extent and profit is $18,000.
Since the gross cost includes the expected normal return the farmer would have received if he had invested his money elsewhere, as well as his fees as a manager, $18,000 is the net economic profit of this type of business. It reflects the favorable economic situation in which farmers were in the late 70s. However, this state of affairs cannot continue for long.
Under perfect competition, when entry of new producers into an industry is fairly easy, any excess of industry profits normal level attracts new firms. An increase in supply, in turn, causes the price of the product to decrease.
When the price was $5 a bushel, the farmers were making an addition to the normal profit, the economic profit. Then the supply of grain increased. Market equilibrium was reached at a lower price of $4.3 per bushel. This price allows farmers only to cover the costs, which, however, include the normal return on capital.
At this price, and even then at a certain level of production, gross income only equals the firm's gross cost. The lack of economic profit does not stimulate the influx of new farmers into the market, and the supply is stabilizing. This is called the long-run equilibrium of the firm under perfect competition. It develops when producers can only cover their costs, including the normal return on invested capital. Producers, in this case farmers, achieve this only at such a volume of production that provides a minimum cost per unit of output. If some firms operate at higher costs, they fail and leave the market.
Allocation Efficiency under Perfect Competition Economists have always favored a perfectly competitive market. They even used this structure as a reference point in the analysis of other types of market structure. What is the meaning of the perfect competition model? That it is ideal in terms of social distribution and use of resources.
In the long run, competitive forces force firms to minimize their average cost of production because the market price is so low that it can only cover costs.
(including the average return on investment), and even then only for the most efficient producers. All firms in an industry, if they are to survive, must operate at the lowest average cost at optimal output. Consumers will only benefit from this, as they will receive the maximum possible volume of goods at the lowest cost. This situation, when the price is equal to the average cost, is called production efficiency.
There is also the concept of resource allocation efficiency
("allocation" efficiency), when there is an ideal distribution of limited resources for the production of goods and services most needed by consumers (with a certain income) 1 . It is believed that efficiency is maximum when no reallocation of resources between different types of activity can benefit one consumer without harming another. And this is possible only if all markets are in a state of long-term equilibrium under conditions of perfect competition.
The profit maximization rule under perfect competition, which establishes the equality of marginal revenue and marginal cost, and therefore price and marginal cost, serves as a guarantee that an optimal set of goods is produced and an ideal allocation of resources is achieved.
Indeed, the market price reflects consumers' assessment of the need to produce an additional unit of the good. Marginal cost reflects the cost of resources to produce an additional unit of output in alternative types activities. If the price exceeds marginal cost, then consumers value it more than an alternative good, and the production of this good should be increased. If the price is less than marginal cost, then consumers value it less than the other good, and production should be curtailed. If in each activity the price equals the marginal cost, then exactly as much of each of the goods as needed by consumers is produced.
In a monopoly, the price exceeds marginal costs, which indicates the inefficiency of this type of market structure in terms of the efficiency of resource allocation. The volume of production of goods is underestimated in comparison with the social need for it.
2. Imperfect competition
It is understood as a market in which at least one of the conditions of pure (perfect) competition is not fulfilled.
In most real markets, the vast majority of products are offered by a limited number of firms. Large corporations, which have concentrated in their hands a significant part of the market supply, find themselves in a special relationship with the market environment. First, by occupying a dominant position in the market, they can significantly influence the conditions for the sale of products. Secondly, relations between market participants are also changing: manufacturers closely monitor the behavior of their competitors, and the reaction to their behavior must be timely.
Competitive relations of this type are called imperfect competition, which is usually divided into three main types:
9. monopolistic competition,
10. oligopoly,
11. pure monopoly.
Monopolistic competition refers to a market situation in which a relatively large number of small producers offer similar but not identical products. For example, personal computers, which differ in the power of hardware, software, graphical output of information and the degree of their "customer focus".
Monopolistic competition does not require the presence of hundreds and thousands of firms, rather a relatively large number of them:
20, 30, 50. Several important features of monopolistic competition follow from this number of firms: each firm has a relatively small share of the total market, so it has very limited control over the market price; collusion aimed at coordinating the actions of firms with the aim of artificially raising prices is almost impossible; with a large number of firms in the industry, there is no mutual dependence between them. Each firm determines its policy, not taking into account the possible reaction on the part of firms competing with it.
In contrast to pure competition, one of the main features of monopolistic competition is product differentiation, which can take a number of different forms: product quality, products can differ in their physical or qualitative parameters; services and conditions related to the sale of goods. This is the courtesy and helpfulness of store employees, the company's reputation for customer service, guarantees for the after-sales operation of goods, etc .; placement, which is understood as convenience and accessibility for buyers in the acquisition of goods. For example, the location of gas stations near highways; sales promotion and packaging.
One of the important meanings of product differentiation is that the buyer is tied to a specific product and a specific seller.
(for example, spare parts for a certain car), which means it loses some of its freedom. The seller, in turn, can influence prices to some extent.
Thus, in conditions of monopolistic competition, economic rivalry focuses not only on price, but also on non-price factors.
Entry into the market of monopolistic competition is quite free and is determined mainly by the amount of capital. However, compared to free competition, it is not so easy and can be limited by firms' patents for their products, copyrights for trademarks, etc. Often, such a situation in the industry market is called monopolistic competition. Each firm produces something special, connected with a certain group of consumers. A good illustration of monopolistic competition is the fast food industry in developed countries. The presence of many chains, such as McDonald's, Crystal, Wendy, and others, using a sandwich called a hamburger as a basic product, does not interfere with their general prosperity. Each firm is trying to bring something of its own to the hamburger, which distinguishes it from its competitor, which ultimately brings success.
Relatively easy access to industries with differentiated competition does not allow firms in these industries to earn monopoly profits for a long time. They spend huge amounts of money on advertising, they emphasize packaging, so that their product differs from competitors' products. For a while, this can create the illusion of a monopoly position. As other firms in the industry do the same, profits eventually begin to decline to normal levels and economic profit disappears.
An oligopoly is a market dominated by several firms, each of which has a significant share of this market 1. Firms in such conditions are interdependent, the behavior of any of them has a direct impact on competitors and is itself influenced by them. Therefore, each market participant must carefully monitor the behavior of rivals, weigh their actions in relation to pricing policy and evaluate the potential consequences of their decisions.
The oligopolistic market is characterized by the fact that penetration into the industry is limited, on the one hand, by the amount of capital necessary for a new firm to enter the industry, and on the other hand, by the control of existing producers over the latest technology and production technology. Because of this, firms can exert some influence on prices (especially with collusion) and make significant profits.
For example, the 13-nation OPEC (Organization of Petroleum Exporting Countries) cartel-type oligopoly has been able to raise prices since
1973 to 1980 from 2.5 dollars. up to 34 dollars for 1 barrel and get the corresponding profit.
Depending on the type of product, an oligopoly is distinguished: pure, differentiated.
Pure oligopoly firms produce a homogeneous standardized product (eg aluminum, cement). An oligopoly that produces a variety of products of the same functional purpose is called differentiated (for example, cars, tires and cameras for them). In such an oligopoly, non-price competition is of particular importance.
Oligopoly largely took place in the command economy of the former USSR and persisted in the CIS countries until today which negatively affects the implementation economic reforms in these countries.
Monopoly of one firm, extremely rare case, but there are many industries in which the market is controlled by several companies. According to the generally accepted criterion, in any industry where four or fewer firms account for half or more of the industry's output, significant market power has been achieved by the leading companies, that is, they can control the prices of the industry's products. However, an oligopoly can also exist at a lower level of industry sales concentration.
If there is some formal agreement between firms regarding pricing or market sharing, the group of firms that signed it is called a cartel. OPEC (Organization of the Petroleum Exporting Countries) is a perfect example of a cartel. This market situation is also called a group monopoly.
Oligopoly mainly exists in forms in which there is no formal agreement between firms to agree on prices and share the market.
Many industries in developed countries are oligopolistic. These usually include the steel, tobacco, automotive, non-ferrous metal industries. The steel and aluminum industries produce a homogeneous product (essentially the same product produced by different firms), while the tobacco and automotive industries produce a differentiated product (an identical but not the same product produced by different firms).
As in a pure monopoly, the excess profits of companies under an oligopoly can be maintained for a long time by limiting the volume of output. Since access to the market for new producers is difficult, and in some cases impossible, the supply does not increase, therefore, the price of the goods does not decrease. The fewer firms in an industry, the easier it is for them to achieve the highest possible monopoly profits.
Under conditions of group control over the market, it is advantageous for firms to cooperate with each other in order to produce the same volume of output and charge the same prices as in a pure monopoly. But when there is no formal agreement between market participants, and even when there is, such cooperation usually cannot last long, since each firm seeks to control a large share of the market.
The possibility of a price war between different firms participating in a group monopoly threatens their profits. That is why so-called price leadership is very often observed in such industries. It lies in the fact that the most powerful firm sets the price first. The rest of the market participants follow it in setting prices, which allows avoiding price competition in the market.
Pure, or absolute, monopoly exists where one firm is the sole producer of a product for which there are no close substitutes.
Absolute monopoly can be viewed from two angles. First, it can be seen as a type of firm. From this point of view, a monopoly is a large corporation that occupies a leading position in a certain area of the economy and uses its dominance to obtain monopoly high profits. For example, corporations such as the De Beers Company of
South Africa", "General Motors" and others. Secondly, the concept of "monopoly" includes the type of economic behavior of the company.
Situations arise in the market when buyers are opposed by a monopoly entrepreneur who produces the bulk of products of a certain type. This assumes that there is only one producer in the industry who has complete control over the supply of the product, which allows him to set the price of his product alone and receive the maximum possible profit. The extent to which monopoly power is used to set prices depends on the availability of close substitutes for the product in the market.
Moreover, it should be noted that in this situation it is not necessary that a large firm be a monopolist. They may also be small businesses. Therefore, when it comes to absolute monopoly, it should be borne in mind that, considering it as a type of firm, we simultaneously consider monopoly as a type of economic behavior of the firm in the market.
A pure monopoly is characterized by the following features: the dominance of one firm, the absence of close substitutes, which forces the buyer to buy goods only from this firm, and the manufacturer to do without wide advertising, without incurring large distribution costs, price dictate, blocking the entry of other firms into the industry.
The latter is explained by the fact that a monopoly firm, as a rule, has a higher profit compared to other firms. This attracts other manufacturers to the industry, for which appropriate barriers are set. The real barriers to entry into the industry are: economies of scale, which require large capital investments from new firms entering the industry in order to maintain a highly efficient economy that provides a level of production not lower than the existing monopoly firm; exclusive rights.
In some countries, the government grants firms the status of the sole seller of goods and services (for example, gas, communications, etc.), but in return for these privileges, it retains the right to regulate the activities of such monopolies in order to exclude the damage that they can bring to non-monopolized industries and the population. ; patents and licenses.
The state guarantees patent protection for new products and production technologies, which provides manufacturers with monopoly positions in the market and guarantees their exclusive rights for a certain period of time. In addition, the state can issue licenses for a certain type of activity and restrict the entry of other firms into the industry; ownership of key raw materials.
A firm that owns or controls a raw material can prevent the creation of competing firms by depriving them of access to raw materials.
In addition to these barriers to entry into the industry, monopolies can also use others, the so-called. dishonest methods: physical elimination of a competitor, pressure on banks to prevent a competitor from obtaining a loan, poaching leading specialists from competing firms, and other methods.
Monopolies that are protected from competition in the form of patents, licenses, etc., are called closed. Those monopolies that do not have such protection are called open 1.
The main tool for establishing their dominance monopolies use the price. There are three types of monopoly prices: monopoly high, at which monopolies sell their products to consumers in order to extract the highest profit; monopolistically low, at which monopolies purchase products (usually raw materials) from suppliers; discriminatory. This different prices installed on the same product in different markets. These markets may differ by consumer groups, by territory, by time (seasonal sale), etc.
Monopoly as a type of economic behavior in the market has positive and negative sides. On the one hand, large-scale production makes it possible to reduce production costs and, in general, save resources; it is less prone to bankruptcy, which means it restrains the growth of unemployment, has more opportunities for research and development, and so on. Society as a whole is interested in the existence of some monopolies, subject to the regulation of their activities by the state, because the scale effect makes it possible to reduce production costs per unit of output and save resources. Such monopolies are called natural. These include water supply companies, communications, transport companies, etc.
On the other hand, in a market economy, monopoly is an obstacle to free competition, which does not contribute to lower prices, improve product quality, etc. and ultimately leads to a decline in the standard of living of the population.
Conclusion
Systematic cost reduction is the main means of increasing the profitability of the firm. In a market economy, when financial support for unprofitable enterprises is an exception to the rule, but not the rule, as it was under the administrative-command system.
The study of the problems of reducing production costs, the development of recommendations in this area is one of the cornerstones of all economic theory.
The following main areas of cost reduction in all areas of the national economy can be distinguished: first, the use of achievements
NTP; secondly, improvement of the organization of production and labor; thirdly, state regulation of economic processes.
The very activity of the firm to achieve cost savings in the vast majority of cases requires costs, labor, capital and finance. The costs of saving costs are then effective when the increase in the beneficial effect (in a wide variety of forms) exceeds the costs of providing savings.
Naturally, a boundary option is also possible, when a decrease in the costs of manufacturing a product does not change it. useful properties, but allows you to reduce the price in the competition. In modern conditions, it is typical not to preserve consumer qualities, but savings on costs per unit of useful effect or other characteristics that are important for the consumer.
The use of the achievements of scientific and technical progress consists, on the one hand, in a more complete use of production capacities, raw materials and materials, including fuel and energy resources, and, on the other hand, in the creation of new, more efficient machines, equipment, and new technological processes.
The most characteristic feature of scientific and technical progress in the second half of the 20th century is the transition to a fundamentally new technological method of production. Its advantages over the existing technological mode of production are not only in higher economic efficiency, but also in the ability to produce qualitatively new material goods, new services that significantly change the whole way of life, the priorities of life values.
So, the most important rule of the firm's strategy in determining the volume of production is the equality of marginal revenue and marginal cost.
Is it possible to achieve this in the Russian economy? Yes, provided that it develops according to the laws of a market economy, and not as in the past. Next, the volumes of production that provide the greatest income are determined. In our administrative-command economy, production volumes were directed down to the enterprise. Analytical services did not set themselves the task of determining the most efficient production volumes, that is, they did not calculate the efficient use of resources, which is necessary for a developed market. So the choice problem best solutions the use of alternative resources could not face the enterprise. As a result, our economy was over-cost compared to the market economy, which led to overspending of resources per unit of output. To overcome this situation, it is necessary to re-profile production for the production of goods that meet the requirements of demand, and through the introduction new technology and technology to help reduce costs. This is the way out of an inefficient economy.
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Why does average variable cost increase as output increases? To answer this question, economic theory uses the category of marginal cost.
Marginal (majority) costs (MC) reflect the increase in total costs caused by an increase in output per unit of output:
The value of marginal cost can be found as the first derivative of the total cost function:
So, marginal cost is the sum of the change in fixed costs per unit of change in output and the change in variable costs per unit of change in output. But after all, fixed costs do not change in the short run, that is:
And this means that marginal cost is, first of all, a change in variable costs in relation to a change in output per unit, that is:
There are important relationships between marginal, average total, and average variable costs. First of all, this concerns the relationship between MC and AVC. If the variable costs per unit of output are higher than marginal costs, then they decrease with each successive unit of output. In this case, if AVC becomes less than MC, then the value of AVC starts to increase. Therefore, equality occurs between these two types of costs when AVC takes a minimum value. The curve of average total costs is the sum of average fixed and average variable costs, and it is variable costs that play the decisive role here. Therefore, the patterns characteristic of the relationship between VC and AVC are valid for MC and ATC. This means that the MC curve crosses the ATC at its minimum.
Marginal cost fully reflects the law of diminishing marginal returns of a factor of production. Since the productivity of each additional unit of a factor of production is less than the productivity of its previous unit, then the cost of attracting this additional unit turns out to be greater. Therefore, an increase in the volume of production associated with the involvement of additional units of production factors is accompanied by an increase in marginal costs. Up to a certain point, these increasing costs are offset by an increase in the total productivity of all units of the given factor used, which is accompanied by an increase in average returns and a decrease in average costs. However, this is only possible under the condition that the total productivity of a factor of production grows faster than the return on attracting each additional unit of this resource decreases, i.e. if the decrease in average cost is faster than the increase in marginal cost.
Therefore, the firm's decision to increase production is always preceded by a comparison of marginal and average costs. If marginal cost is below average, then the expansion of production will lead to a further decrease in average cost. If, on the other hand, marginal costs are greater than average, then average costs can only be reduced by reducing output. The minimum average cost is achieved when the average and marginal costs of production are equal. Accordingly, the moment of the most efficient allocation of resources within the firm is characterized by the achievement of a minimum level of average production costs.
Thus, the firm must monitor the formation of not only total, but also marginal and average costs, compare their movement with the dynamics of marginal and average products. And then the firm's production technology can obtain an optimal structure that ensures the formation of minimum average production costs, high growth rates of marginal product, and a rapid decrease in marginal labor costs.
All types of costs of the company in the short run are divided into fixed and variable.
fixed costs(FC - fixed cost) - such costs, the value of which remains constant when the volume of output changes. Fixed costs are constant at any level of production. The firm must bear them even in the case when it does not produce products.
variable costs(VC - variable cost) - these are costs, the value of which changes with a change in the volume of output. Variable costs increase as output increases.
Gross costs(TC - total cost) is the sum of fixed and variable costs. At a zero level of output, gross costs are equal to fixed costs. As the volume of production increases, they increase in accordance with the growth of variable costs.
Examples of different types of costs should be given and their change due to the law of diminishing returns should be explained.
The average costs of the firm depend on the value of the total fixed, total variable and gross costs. Medium costs are determined per unit of output. They are commonly used for comparison with unit price.
In accordance with the structure of total costs, firms distinguish between average fixed (AFC - average fixed cost), average variables (AVC - average variable cost), average gross (ATC - average total cost) costs. They are defined as follows:
ATC=TC:Q=AFC+AVC
One important indicator is marginal cost. marginal cost(MC - marginal cost) - this is the additional cost associated with the production of each additional unit of output. In other words, they characterize the change in gross costs caused by the release of each additional unit of output. In other words, they characterize the change in gross costs caused by the release of each additional unit of output. Marginal cost is defined as follows:
If ΔQ = 1, then MC = ΔTC = ΔVC.
The dynamics of the total, average and marginal costs of the firm using hypothetical data is given in Table.
Dynamics of total, marginal and average costs of the firm in the short run
| Output volume, units Q | Total costs, rub. | Marginal cost, p. MS | Average costs, r. | ||||
| permanent FC | VC variables | gross vehicle | permanent AFCs | AVC variables | gross ATS | ||
| 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 |
| 0 | 100 | 0 | 100 | — | — | — | — |
| 1 | 100 | 50 | 150 | 50 | 100 | 50 | 150 |
| 2 | 100 | 85 | 185 | 35 | 50 | 42,5 | 92,5 |
| 3 | 100 | 110 | 210 | 25 | 33,3 | 36,7 | 70 |
| 4 | 100 | 127 | 227 | 17 | 25 | 31,8 | 56,8 |
| 5 | 100 | 140 | 240 | 13 | 20 | 28 | 48 |
| 6 | 100 | 152 | 252 | 12 | 16,7 | 25,3 | 42 |
| 7 | 100 | 165 | 265 | 13 | 14,3 | 23,6 | 37,9 |
| 8 | 100 | 181 | 281 | 16 | 12,5 | 22,6 | 35,1 |
| 9 | 100 | 201 | 301 | 20 | 11,1 | 22,3 | 33,4 |
| 10 | 100 | 226 | 326 | 25 | 10 | 22,6 | 32,6 |
| 11 | 100 | 257 | 357 | 31 | 9,1 | 23,4 | 32,5 |
| 12 | 100 | 303 | 403 | 46 | 8,3 | 25,3 | 33,6 |
| 13 | 100 | 370 | 470 | 67 | 7,7 | 28,5 | 36,2 |
| 14 | 100 | 460 | 560 | 90 | 7,1 | 32,9 | 40 |
| 15 | 100 | 580 | 680 | 120 | 6,7 | 38,6 | 45,3 |
| 16 | 100 | 750 | 850 | 170 | 6,3 | 46,8 | 53,1 |
Based on the table. we will construct graphs of fixed, variable and gross, as well as average and marginal costs.
The fixed cost graph FC is a horizontal line. Graphs of variables VC and gross TC costs have a positive slope. In this case, the steepness of the curves VC and TC first decreases, and then, as a result of the law of diminishing returns, increases.
Average fixed cost AFC has a negative slope. The curves for average variable costs AVC, average gross costs ATC, and marginal costs MC are arcuate, i.e., they first decrease, reach a minimum, and then become towering.
Attracts attention dependence between plots of mean variablesAVCand marginal MC costs, as well as between curves of average gross ATC and marginal MC costs. As can be seen in the figure, the MC curve intersects the AVC and ATC curves at their minimum points. This is because as long as the marginal, or incremental, cost associated with the production of each additional unit of output is less than the average variable or average gross costs that were before the production of this unit, the average cost decreases. However, when the marginal cost of a particular unit of output exceeds the average that was before its manufacture, the average variable and average total costs begin to increase. Consequently, the equality of marginal costs with average variable and average total costs (points of intersection of the MC graph with the AVC and ATC curves) is achieved at the minimum value of the latter.
Between marginal productivity and marginal cost there is a reverse addiction. As long as the marginal productivity of a variable resource increases and the law of diminishing returns does not apply, marginal cost will decrease. When marginal productivity reaches its maximum, marginal cost is at its minimum. Then, as the law of diminishing returns kicks in and marginal productivity declines, marginal cost rises. Thus, the marginal cost curve MC is a mirror image of the marginal productivity curve MP. A similar relationship also exists between the graphs of average productivity and average variable costs.
