The cost analysis could help managerial level taking decisions-related to gain more profit. The cost structure will affect the pricing strategy and keep the business remain competitive. Understanding the cost calculation as long as the production process either in the short-run or in the long-run makes a cost structure decisions more accurate. I write a summary about the cost function in the short and long-run on Keat, P. and Phillip Young. 2008. Managerial Economics, 6th edition. Pearson (KY) e-book.
Read : What is cost structure ?
THE SHORT RUN COST ANALYSIS FUNCTION
In the short-run cost analysis function, productivity and cost are inversely related. In general, marginal pulls average up or down depending on if it is above or below average. If the marginal cost more than the average variable cost, then the average variable cost is rising. But when the Marginal product of labor is more than the Average Product labor, the average product of labor will decrease.
If the additional cost less than the average variable cost, the average variable cost will decrease because the additional is low. If the additional product is more than the average product, the average product will increase. So the changes in product output increase with fix cost constant, the average will decrease due to additional cost decrease.
INCREASING COST EFFICIENCY IN THE SHORT RUN
With the assumption that the firm is in the best operating condition in the short run, we can conclude that :
- To make efficiency in the short run, the decreasing price of input will make a downward shift in the firm’s short-run cost curves.
- Reduce the fixed cost will make the average cost curve to shift downward.
- Reduce the variable cost will make average cost, average variable cost, marginal cost to shift.
- Minimum marginal cost and average cost will happen when the output levels of marginal cost and average variable cost at the same level.
- The minimum average cost will happen if the larger output level than the average cost in this instance.
THE LONG RUN COST ANALYSIS FUNCTION
In the long run cost analysis condition, there is no fixed input and no fixed cost, all costs are variable in the long run. Besides the short-run analysis for the production, the company should consider making managerial decisions related to production in the long run. For the long-run cost function explanation, we can use the assumption that the greater amount output results from increases in all firm’s input. Then implies the assumption, there is no incur cost if the company does not produce any output. In the long-run cost function, the marginal cost increase as the output increase but no in a constant rate. This condition related to the return of scale. If the long-run average cost decline as the increase of output, the firm experiencing economies of scale. But if the firms are long-run average cost increase as the increase of output, then the firm experiencing diseconomies of scale.
When a firm increases all its inputs by some proportion and results in the output in greater proportion, the firm at a return to scale condition. Assuming the price of input constant over time, the firm’s output increasing by some percentage, and its total cost of production increases at a lesser percentage. The short-run cost function is affected by increasing and diminishing return to individual factors, a phenomenon that is assumed to take effect when at least one of the inputs is held constant and the long-run function is affected by increasing and decreasing return to scale, a phenomenon as assumed to take effect when all the firm’s inputs are allowed to vary.
ECONOMIES SCALES AND ECONOMIC SCOPE
There is a factor affecting economies and diseconomies of scale :
Possible reasons for economies of scale
- Specialization in the use of labor and capital
- Indivisible nature of many types of capital equipment
- The productive capacity of capital equipment rises faster than the purchase price
- Economies in maintaining an inventory of replacement parts and maintenance personnel
- Discounts from bulk purchases
- Lower cost of raising capital funds
- Spreading of promotional and research and development costs
- Management efficiencies (line and staff)
Possible reasons for diseconomies of scale
- The disproportionate rise in transportation costs
- Input market imperfections
- Management coordination and control problems
- The disproportionate rise in staff indirect labor
- The economy’s scope is the reduction of the firm’s unit cost by producing two or more goods or services jointly rather than separately.
EXAMPLES OF WAYS COMPANIES HAVE CUT COSTS TO REMAIN COMPETITIVE
To increase revenue and company growth, the cost-cutting methods or procedures that firms have implemented to remain competitive. There are examples of the cost-cutting method in the company :
- The strategic use cost. Use cost leadership as the core of its strategy for competing in the marketplace.
- Reduction in the cost of materials. Manufacturers are constantly seeking to cut costs by materials substitution and modification. Cost-saving can come for other reasons besides using fewer materials or less expensive materials.
- Using information technology (IT) to reduce cost.
- Reduction of process costs.
- Relocation to lower-wage countries or regions.
- Mergers, consolidations, and subsequent downsizing.
- Layoffs and plant closings.
- Reduction of fixed assets.
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