Cost of production is very important for every firm. Any firm which does production undergoes three main questions. That’s why every entrepreneur takes care of these three and then take a decision.
- What quantity of total output to produce?
- What will be the production cost of the output?
- How much revenue will be earned on the sale of the output?
A firm always thinks about its cost of production and compares its revenue with its cost. So, here I will discuss various aspects of firm’s product, costs, and revenues. Just because a firm has to maximize its profit and minimize the cost. in order to make it more clear, the concept of cost and revenue in economics must be clear. So, the firm always does its cost and revenue analysis.
A firm’s product has three aspects such as;
Total product is the total output which firms produce with the four factors of production. For example, if a shoe manufacturer manufactures 3000 pairs of shoes per month. It will be the total product of that company for a month.
Marginal means additional, so marginal product is the additional product due to an addition to the variable factor. For example, 10 labors in a shoe company produce 3000 pairs of shoes.by adding one more labor, 11th unit of labor, the total production becomes 3100 now. So, the marginal product of the 11th labor is 100.
Average product is the average output which each unit of labor produces. So, divide the total output by the input variable, you will get the average product.
Average product= Total Product/Input Variable
For example, a firm produces 3000 pairs of shoes by hiring 10 units of labor. So, here the average product will be,
The average product is 300 which means a single labor produces 300 pairs of shoes on average.
Cost of Production
As you know, the firm hires four factors of production in order to produce goods or service. The four factors of production are given rewards against the service and sum total of rewards is the cost of production which an entrepreneur bears. Therefore, an entrepreneur always tries to minimize the cost. The total cost of a firm includes fixed cost and variable cost.
The total rewards paid for the factors of production is called total cost. The total cost of a firm includes;
TC= Fixed Cost + Variable Cost
Total Fixed Cost:
Fixed costs are associated with the costs which don’t vary with the level of production. Such cost includes salary, insurance, and rent etc.
Total Variable Cost:
The type of the cost which varies with the level of production in called variable cost. Such cost includes raw material, and labor cost etc.
Average cost/ Average Total Cost:
You can also call it unit cost. It shows the per unit cost of a firm and you can easily calculate it by dividing the total cost by the number of output produced. Moreover, if you want to be more clear there is an example
if the total cost of producing 3000 pairs of shoes are 10000 (the 10,000 includes both the fixed and variable cost) and the average cost will be;
Average Fixed Cost:
The average fixed cost tells us about the per unit fixed cost of a firm. Therefore, you can calculate it by dividing the total fixed cost by the unit of output.
I.e. Total fixed cost/Total output
Average Variable Cost:
The average variable cost tells us about the per unit variable cost of the firm. Whereas, the formula for average variable cost is as follows;
Total Variable Cost/Total Output
Marginal means additional, and it is an additional cost per additional unit of output. That is why, when we increase the output by one unit, the total cost will also vary and increase. However, the change in total cost due to change in the total output is called marginal cost.
The formula for marginal cost is
The total earnings of an entrepreneur which he receives after selling the goods or services. Revenue is the product of price and quantity.
Revenue= Price* Quantity
It is the additional revenue which an entrepreneur earns by selling the additional unit of output. Marginal revenue in economics is a very important concept. we can calculate MR as;
The average revenue of a firm is the revenue per unit of the output. you can obtain AR if you divide the total revenue by the total output.
However, any firm which does production always tries to maximize their profit. They always think about their cost of production and profit. So, the profit is maximum when total revenue becomes equal to the total cost and this is the point where the firm reaches its equilibrium.