Creation Of Utility: Factors Of Production, Costs, Pricing And Competitive Strategies

Short and Long-Run Production

Discuss About The Creation Of Utility Is Referred Production.

Creation of utility is referred to as production. There are factor inputs that are converted into output (Rasmussen, 2011). The factor inputs include labor and capital as the dominant resources used.  The relationship that exists between the factor inputs and output can be explained using a production function. management, the process by which inputs are converted into output is referred to as production.

The time a variable takes to be varied is what defines either the short run or long run. Consequently, there is the short run and long run production (Horsley & Wrobel, 2016). In the short run, the variables cannot be changed. In this case, the production function is short run since at least one of the factors cannot be changed. In this way, all the inputs used in the production cannot be varied. Hence, at least one-factor input is fixed in the short run.

On the other hand, in the long run, all the factors of production can be varied. It means that all the resources like labor and capital can be changed. The reason is that a firm has a long period to make decisions (Baumol & Blinder, 2012). In the long run, decisions to invest in a new plant can be undertaken unlike in the short term where decisions involve the existing plant.

Costs. There are different costs involved in the production. According to Mankiw (2011), Variable costs are dependent on the level of quantity produced. It means that changing the amount would change the variable cost. Fixed costs are independent of the output. Changing the quantity of production would leave the fixed costs unchanged. It means that variable costs are long run because they can be altered while fixed costs are short-term since they cannot be changed over time.

Another type of cost is the total cost. The economic cost of production is the total cost (TC). It involves the opportunity costs of each production factor.  Hence, it consists of the cost of the alternative chosen plus the benefit that the foregone opportunity would have provided if chosen (Tragakes, 2011). The benefit foregone is the opportunity cost of production. In other words, the accounting costs (variable plus fixed costs) plus opportunity cost yields the economic cost.

Additionally, there is the average and marginal costs. Marginal cost is the change in total cost following a unit change in quantity produced.  It is the cost of producing an extra unit (Samuelson & Nordhaus, 2010). For example the production cost of one car is $20000. The total cost of making two cars is $25000. The marginal cost of producing the second car is $5000. On the other hand, the average cost is the cost per unit. It is obtained by dividing the total cost with the number of units produced. For example if the production cost of two cars is $50000, the average costs is &25000. Another way would be to add up the average fixed cost and average variable costs to obtain the average costs. The different costs of production influence the total cost of production.

Costs in Production

Pricing Strategies. Firms have different pricing strategies. The dominant strategies are the marginal cost pricing and cost-plus pricing (Govindarajan, 2009). In marginal cost pricing, the price is set equal to the cost of producing an extra unit which is referred to marginal cost.  Mostly, the method is applicable in the competitive market. Under the cost-plus pricing, other costs like the material cost and overhead costs are added to create a profit margin. The method is often used in the monopoly market structure. The pricing strategies are significant to an organization. Firms can use the pricing strategies to protect themselves from new entrants by preventing them. Also, organizations can use pricing methods to obtain a new market share. Moreover, companies use pricing strategies to maximize their profits.

Different factors influence the decision of the pricing strategy.  The level of competition is influential. Firms must be aware of the actions that their competitors could take. Failure to consider their opponent’s actions would make them lose their competitive advantage. According to Narula (2006), consumers are very selective when making their decisions. Rational consumers would ensure that they maximize their benefits from their money. One would not buy an expensive product that serves the same purpose with another cheaper product. Buyers prefer to buy cheaper commodities. Again, buyers can easily make price comparisons from the internet because of the increased use of technology. Therefore firms must be attentive and selective to the pricing strategy they apply.

Competitive Strategies. Sustainable competitive strategies determines the success of a business. Competitive strategies drives the firm’s profitability either above or below the industry average. Firms with a solid competitive advantage maintain their profitability level above the industry’s position. There are two major ways in which firms can be competitive which are cost leadership and differentiation. Cost leadership dictates that firms should pursue economies of scale and have appropriate technology. In addition, firms should have strategic location. For example, nearness to the market and source of raw material to reduce on production cost leading to increased profitability (Moore & Longenecker, 2008). In differentiation, firms seek to have a unique product that has been tailored to meet customer’s demand. A firm would look at the elements that buyers perceive to be important and work on their product to ensure that they meet the demand of consumers. Hence, competitive strategies are vital for the success of an organization.

2. Derivation of the cost functions

Fixed Costs (FC).Fixed costs are costs that are independent of output. The fixed cost function can be obtained by subtracting the variable cost from the total costs as shown

Pricing Strategies

TC = FC + VC

Given that C = 2000 + 5Q + 2Q³

VC = 5Q + 2Q³

 FC = TC - VC

Therefore, FC = (Q = 2000 + 5Q + 2Q³) – (5Q + 2Q³)

            FC = 2000

Variable Costs (VC). Variable costs are costs that are dependent on quantity produced.

The variable cost function can be obtained by subtracting fixed costs from total costs.

Given that C = 2000 + 5Q + 2Q³ and FC = 2000

VC = TC – FC

VC = (2000 + 5Q + 2Q³) – 2000

VC = 5Q + 2Q³

Average Cost (AC)

It is the cost per unit produced. It can be obtained by dividing the total cost with the units produced.

Given that C = 2000 + 5Q + 2Q³ and the units produced are Q

It follows that, AC = (2000 + 5Q + 2Q³) ÷ Q

AC = 5 + 2000?Q + 2Q²

Marginal Costs (MC). It is defined as the cost of producing an extra unit of output.

To obtain marginal cost curve, you differentiate the total cost curve with respect to Q.

C = 2000 + 5Q + 2Q³

Differentiating the total cost function, you obtain the marginal cost function:

MC = dC /dQ

MC = 5 + 6Q²

Firms maximize their revenue where MR = MC (Hall & Lieberman, 2013). Where firms maximize their revenue, the output is maximum. For example in the above graphical representation, the maximizing Quantity is Q₀. The level of output can be obtained using a mathematical model. Given that a firm maximizes output where MR = MC, in perfect competition it would mean that P = MC. It is because of the elastic demand curve which gives MR = P.

4. Meaning of the 0.5

The 0.5 is the output elasticities. It shows how the output changes with the change in inputs which are capital and labor.

5. Maximum profit conditions in the short run and long run

In the short run, firms maximize profits where MR = MC. Firms maximize profits where MC curve intersects the AC curve from below.

6. The short run

Using P = MC and given that P = 100, MC = 5 + 6Q²

       100 = 5 + 6Q²

        6Q² = 95

Q² = 15.83

Q = 3.98

In the long run

AC = 5 + 2000?Q + 2Q²

dAC ?dQ = -2000?Q² + 4Q

MC = 5 + 6Q²

Equating the two equations,

-2000?Q² + 4Q = 5 + 6Q²

Multiplying both sides by Q you get,

5Q + 6Q³ = 2000 + 5Q + 2Q²

Collecting the like terms together,

4Q³ = 2000

Q = 12.6

References

Baumol, W. J., & Blinder, A. S. (2012). Macroeconomics: Principles & policy. Mason, OH: South-Western, Cengage Learning.

Govindarajan, M. (2009). Marketing management: Concepts, cases, challenges and trends. New Delhi, II: Prentice-Hall.

Hall, R. E., & Lieberman, M. (2013). Economics: Principles & applications. Australia: South-Western Cengage Learning.

Horsley, A., & Wrobel, A. J. (2016). The Short-Run Approach to Long-Run Equilibrium in Competitive Markets: A General Theory with Application to Peak-Load Pricing with Storage. Cham: Springer International Publishing.

Mankiw, N. G. (2011). Essentials of economics. Cincinnati, Ohio: South-Western.

Moore, C. W., & Longenecker, J. G. (2008). Managing small business: An entrepreneurial emphasis. Australia: South-Western/Cengage Learning.

Narula, U. (2006). Business communication practices: Modern trends. New Delhi: Atlantic.

Rasmussen, S. (2011). Production Economics [recurso electrónico]: The Basic Theory of Production Optimisation. Alemania: Springer Berlin Heidelberg.

Samuelson, P. A., & Nordhaus, W. D. (2010). Economics. New Delhi: Tata McGraw Hill.

Tragakes, E. (2011). Economics for the IB Diploma. Cambridge: Cambridge University Press.