On our final Learning Path of our series on cost analysis, we’ll learn about cost efficiency, how to reduce costs while maintaining volume and quality. Therefore (and starting with economies of scale, as a link to last week’s LP), we could ask ourselves the following questions: will my costs fall if I produce more? Or if I produce a wider portfolio? Or what is the role training and specialisation can play in increasing efficiency?

After understanding how cost efficiency can be achieved, we turn to the main critiques of neoclassical cost analysis. Up to now, everything sounded just as what they’ve been teaching us at school and college. However, a few theories stood up against all this, mainly form Industrial Organization theory.

In this LP, we’ll start by looking on how to improve cost efficiency, with:

• Economies of scale, looking at how our levels of production can help us maximise cost efficiency;
• Economies of scope, looking at product portfolio size in cost reduction;
• Economies of learning, looking at the impact of know how on cost, an analysing in detail
• Learning curves and
• Experience curves.

Then, we’ll learn about the main critiques against neoclassical cost analysis:

• Industrial organization, analysing its main authors and concepts;
• George Stigler, one of the key figures of Industrial Organization;
• Stigler’s cost analysis theory, which greatly differed from classical economies of scale;
• X-inefficiency, an idea put forward by Harvey Leibenstein.

Having covered the basics of cost analysis, we are in a position to explore other important aspects of cost efficiency. For example, will my costs fall if I produce more? As economies near perfection, costs efficiency becomes increasingly crucial, so much so that investment plays a greater role. But just how and where that investment in cost management should be directed is the subject of our second LP on cost analysis. In this LP, we’ll start where we left in our previous LP:

Short run cost analysis:

• Period analysis, where will see what determines the short and the long run.
• Short run cost analysis, as seen last week, is about dealing properly with fixed costs. Continue reading →

Two things determine profits: income, or turnover (the price at which we sell something) and costs (how much we spent making what we sell).  Therefore, knowing how much our costs are going to be is essential when planning the viability of a business, especially given that in a perfect economy, price is not determined by us but by what the market dictates. This is therefore essential before we can put all these factors into place and look at the whole picture: what to produce, how much of it to produce, and whether we will make anything out of it.

In this first LP on costs, we will start by remembering what we learned a few weeks back:

• Production maximisation, then
• cost minimisation and put them together in
• production duality analysis.

Then, we’ll look at the framework in which we analyse costs: the types, what determines them and how this determines our choices regarding production levels, starting with:

• Period analysis, learning about what determines the short and long run; then move onto the basic
• types of cost, which will affect
• average and marginal costs and their importance, before putting it together in
• cost analysis in the short run.

This second Learning Path on production will draw on the basics we saw in Production I and add several extra factors to our analysis. We will basically introduce three new parameters to our possibilities: we will add a time frame and see how this shapes our choices, we will introduce the ability to produce more than one good or service, and we will also take a first look at prices, production costs and competition as a whole market dynamic.

Under perfect competition, prices are determined by market forces. If the price of a specific type of bog standard, hexagonal, 15mm screw, for example, is  0.01€, there is nothing stopping you from trying to sell it at ten times the price, but you probably won’t last very long. You’re better off deciding whether you can make a profit selling at that price before you start producing at all. In terms of labour and capital, we suppose they are interchangeable, as we saw when we looked at the MRTS. Depending on the going price of labour (wages) and capital (machinery and interest rates), you will choose one or the other or a combination of both: whatever is most productive per euro spent.

All we can now do is set our level of production. We know that marginal productivity drops with each added unit of labour (or capital), under the law of diminishing returns. When, therefore, should we stop? We could try cramming our screw factory with workers until they begin getting in each others’ way and start having negative productivity (the equivalent of getting them to work 20 hour days until they are tired enough to start doing more harm than good), but not only is this not health and safety compliant, it is also much too late. The simple answer is that we stop when it is not worth hiring any more workers. This idea of ‘worth’ will depend on various factors, and is the subject of our analysis in this second LP.

So, let’s define these factors and get started. We will begin by looking at the concept of

• Static period analysis, introducing one of the main factors we will have to juggle.

This will lead us onto our first scenario, the short run, where we will look at:

• Production functions and
• Production analysis in the Short Run

In the next section we will cover the long run, with:

• Analysis in the Long Run and
• Returns to scale

Before an entry on

• Production analysis in the Very Long Run

In the final section of this LP, we will introduce another factor, multi-product analysis, in two entries on:

• Production possibility frontier and
• Multi-product function.