economics and finance for business

production costs, supply, saving costs

 Content

1. Fixed and variable costs, economies of scale

2. Average costs: (i) when do you profit, (ii) lose money but
still operate, (iii) decide to shutdown?

3. Cost-cutting strategies

4. Marginal cost and maximising profit, supply curve,

elasticity
 If you have a business…

How will you manage your costs?

 Fixed costs (a.k.a. overhead)

Costs are constant, even though the quantity you produce

is different

Can you name fixed costs? Rent, the salary of full-time

workers, any insurance that you may pay, the cost of
machinery/equipment purchased etc.

RENT ADVERTISEMENT COST

 A strategy to reduce fixed costs

“Spread the overhead”

Spread fixed costs over more units of input; produce more

and make the fixed cost low for per product produced

E.g.: Rent is $1000 a month. Make 10 pizza, fixed cost per

pizza is $100. You will have to sell each pizza for at least
$100. Bad idea. Make 1000 pizzas, fixed cost per pizza is
$1
 Variable costs (changing cost)

Raw material; wages for workers (what else?)

Rises as an increasing quantity of your product is made

 A strategy to reduce variable costs

Hire workers mostly during peak hours; shed workers at

other times
 In the short run
In economics, there’s the short run, when you cannot add
manufactured capital, but you can add human capital

Meaning, you have only one shop. Only thing you can do
is add more workers (more of the variable cost component
of your business)

More workers, more pizza. Two or three workers more

productive than one. But hire too many, the marginal/extra
output they make doesn’t go up by much (they loiter
around and shirk from work)  the law of diminishing
marginal returns
In the long run
Now, you can buy more shops

You don’t face the problem of unproductive workers, because

when you hire extra workers, you can put them in new shops
and they will all be productive

Costs per product produced can keep going down. You can
produced tons of pizzas now. Because you can produce tons of
pizzas, you gain cost savings related to the ‘economies of
scale’. Do you know what creates ‘economies of scale’, and the
associated cost savings? Do you know why as you increase
quantity produced further still, you may face ‘diseconomies of
scale’? Read up about them, Google about them, know them.
 In the long run
Now, you can buy more shops

You don’t face the problem of unproductive workers, because

when you hire extra workers, you can put them in new shops
and they will all be productive

Costs per product produced can keep going down. You can
produced tons of pizzas now. Because you can produce tons of
pizzas, you gain cost savings related to the ‘economies of
scale’. Do you know what are the reasons for these cost
savings? Do you know why as you increase quantity produced
further still, you may face ‘diseconomies of scale’? Why?
Total costs (in the short run)
Average costs (in the short run)
Where is your loss-minimisation point and shut-down
point?

10

2
 Cost-shifting
The institutional economist K.W. Kapp, in his book The Social
Costs of Business Enterprise, pointed out that businesses will
attempt to cut costs by shifting these costs onto its workers, the
public or the environment, whenever and wherever they can
 Other cost-cutting strategies
Check out the extra material provided on Moodle
The supply curve
Factors that cause shifts in supply curve

What causes supply to

increase (shift
rightwards)?

What causes supply to

decrease (shift
leftwards)?
Price elasticity of supply

Do you know how the supply curve’s slope will be when the
supply is price elastic and price inelastic?

It is will be similar to the price elasticity of demand

Be sure to know how the curve will be like; what elastic/inelastic

supply means (what causes these?); and what the elasticity
‘scores’ are like for elastic/inelastic supply
Price elasticity of supply
Where does the supply curve come from?

It is part of another cost curve called the ‘marginal cost’ curve

Do you know what marginal cost is?

Where does the supply curve come from?
$
Margina
l Costs

Supply
curve

Q
 Where does the marginal cost curve come from? The
marginal cost is the cost of making ‘one more product’

9th

70
2nd
1st
30
50
What quantity should you produce to maximise your
profit?
Profit
$ maximised
Margina
l Costs

Price

Cost

Q
200 pizzas
“Do I need to know the technical
details of cost curves?”

In a word, no. For example, slide 22 is just to illustrate to you how marginal cost is
calculated. You do not need to have to draw these or demonstrate these things in your
assessments.

What you do need to know are the general ideas contained in this topic, such as:

- What affects supply… that is, what increases it, decreases it?

- What are the consequences of an inelastic or elastic supply… what causes them?
What industries or situations might be characterised by inelastic or elastic supply?

In the short run (meaning, when you still have one shop and cannot expand capital…
that is, have more shops, more equipment):

- At what market price should you keep producing your pizza (or any other product),
and at what market price might it be wise to temporarily shut down operations
(average cost curves)

- What quantity of your pizza should you produce from your shop that maximises your
profit level? (marginal cost curve)
“What else must I know?”
You must understand the types of variable and fixed costs different kinds of
businesses in different industries might have (from car to Internet to service
companies).

You must know how to apply the ideas you learnt this week.

For example, can you manage variable and fixed costs to minimise waste – that is, to
cost-save or to cost-cut – so that profits are sustained. Could you cleverly shift costs
as well to achieve cost savings?

Should you cost-cut aggressively or ruthlessly at all cost in a business? Perhaps not a
good idea (why?): see, e.g., tinyurl.com/heinzcost

Know how companies exploit labour (and maybe you) to save costs (Reading #3)