Production and Cost Analysis: Where to Start

Sim­i­larly, firms must also mon­i­tor the tech­nol­ogy they use for pro­duc­tion. Firms might either use labor-inten­sive fac­to­ries or cap­i­tal-inten­sive fac­to­ries, depend­ing on which one helps them max­i­mize their profit.

The area in which firms oper­ate helps them to deter­mine which pro­duc­tion deci­sion will be ben­e­fi­cial for them. Labor-inten­sive fac­to­ries are mostly used in coun­tries with low wages. Like­wise, cap­i­tal-inten­sive mod­ern fac­to­ries are used when a high num­ber of labor­ers is not required or when a firm oper­ates in a coun­try where there are high wages.

So a firm weighs three things when mak­ing pro­duc­tion deci­sions:

• the cost of the inputs used for pro­duc­tion
• the tech­nol­ogy used for pro­duc­tion
• the area in which it oper­ates

Pro­duc­tion is a cru­cial com­po­nent of eco­nom­ics and is essen­tial for any econ­omy to func­tion. Com­pa­nies use a vari­ety of inputs, such as land, labour, and cap­i­tal, to cre­ate goods or ser­vices that are later used by cus­tomers. In addi­tion to max­i­miz­ing the use of resources, pro­duc­tion also gen­er­ates employ­ment oppor­tu­ni­ties. Lastly, eco­nomic effi­ciency can be attained if the prod­ucts and ser­vices cre­ated are deliv­ered to the right cus­tomers.

Fac­tors of pro­duc­tion are the tan­gi­ble and intan­gi­ble resources that are used by the firm to pro­duce goods and ser­vices. A fir­m's effi­ciency is mea­sured by look­ing at how the firm uti­lizes its fac­tors of pro­duc­tion. There are four fac­tors of pro­duc­tion, and using each of them well mat­ters for a com­pa­ny's con­tin­ued growth:

• Land: nat­ural resources such as land, water and min­er­als
• Labour: the phys­i­cal and men­tal effort of work­ers
• Cap­i­tal: machin­ery, build­ings, tools and other man-made aids to pro­duc­tion
• Entre­pre­neur­ship: the organ­is­ing and risk-tak­ing that brings the other three together

Key terms#

Pro­duc­tion (Prod.)

Pro­duc­tion is the process of mak­ing or man­u­fac­tur­ing goods and prod­ucts from raw mate­ri­als or com­po­nents.

Human Cap­i­tal (HC)

Human cap­i­tal is an intan­gi­ble asset that is a sum of the eco­nomic value of an employee’s expe­ri­ence and skills.

Total Prod­uct (TP)

Total prod­uct is the total quan­tity of a com­mod­ity pro­duced in a given period.

Com­mon ques­tions#

What is the for­mula for the pro­duc­tion func­tion?#

A com­mon form of the pro­duc­tion func­tion is q = AF(K, L), where q is the total out­put, A rep­re­sents tech­nol­ogy, and F(K, L) is a func­tion of the inputs, K for cap­i­tal and L for labour.

How is pro­duc­tion clas­si­fied based on the process?#

Pro­duc­tion is usu­ally clas­si­fied into three stages:

• Pri­mary pro­duc­tion: the first stage, in which raw mate­ri­als are extracted or grown, as in farm­ing, fish­ing, forestry and min­ing.
• Sec­ondary pro­duc­tion: the mid­dle stage, in which raw mate­ri­als are turned into fin­ished goods through man­u­fac­tur­ing and con­struc­tion, using machin­ery and man­ual work together.
• Ter­tiary pro­duc­tion: the final stage, made up of the ser­vices that get goods to cus­tomers and sup­port the econ­omy, such as trans­port, pack­ag­ing, dis­tri­b­u­tion, retail and bank­ing.