Production, costs, and pricing

In microeconomics, production is the act of making things, in particular the act of making products that will be traded or sold commercially. Production decisions concentrate on what goods to produce, how to produce them, the costs of producing them, and optimizing the mix of resource inputs used in their production. This production information can then be combined with market information (like demand and marginal revenue) to determine the quantity of products to produce and the optimum 'pricing'(Imaga, 1994: 384).


(In macroeconomics, production is measured by gross domestic product and other measures of national income and output.)

Aspects of production and pricing theory

* Production theory basics
o production efficiency
o factors of production
o total, average, and marginal product curves
o marginal productivity
o isoquants & isocosts
o the marginal rate of technical substitution
* Economic rent
o classical factor rents
o Paretian factor rents
* Equilibrium income distribution
* Production possibility frontier
o what products are possible given your resources
o the trade-off between producing one product rather than another
o the marginal rate of transformation
* Production function
o inputs
o diminishing returns to inputs
o the stages of production
o shifts in a production function
* Cost theory
o the different types of costs
+ opportunity cost
+ accounting cost or historical costs
+ transaction cost
+ sunk cost
+ marginal cost
o the isocost line
* Cost-of-production theory of value
* Long-run cost and production functions
o long-run average cost
o long-run production function and efficiency
o returns to scale and isoclines
o minimum efficient scale
o plant capacity
* Economies of density
* Economies of scale
o the efficiency consequences of increasing or decreasing the level of production
* Economies of scope
o the efficiency consequences of increasing or decreasing the number of different types of products produced, promoted, and distributed
* Optimum factor allocation
o output elasticity of factor costs
o marginal revenue product
o marginal resource cost
* Pricing
o various aspects of the pricing decision
* Transfer pricing
o selling within a multi-divisional company
* Joint product pricing
o price setting when two products are linked
* Price discrimination
o different prices to different buyers
o types of price discrimination
o yield management
* Price skimming
o price discrimination over time
* Two part tariffs
o charging a price comprised of two parts, usually an initial fee and an ongoing fee
* Price points
o the effects of a non-linear demand curve on pricing
* Cost-plus pricing
o a markup is applied to a cost term in order to calculate price
o cost-plus pricing with elasticity considerations
o cost plus pricing is often used along with break even analysis
* Rate of return pricing
o calculate price based on the required rate of return on investment, or rate of return on sales
* Profit maximization
o determining the optimum price and quantity
o the totals approach
o the marginal approach of production

Production systems

Mass Production

Characteristics
* Equipment is expensive and used for a solitary purpose.
* A very small variety of goods are produced.
* Goods are transported from one fixed work station to another.

Advantages
* Greater specialisation.
* Optimum utilisation of workers and machinery.
* Low production costs per unit.
* Low stock-piling costs.
* Restricted handling of materials.
* Production control is simplified.
* High sales earning profit.
* Division of labour.
* Equipment standardized.
* Products uniform.

Disadvantages
* Expensive capital for equipments/machineries.
* Expensive redesigning
* Products may lack quality
* Staff may be demotivated since work is repetitive and boring

Jobbing

Advantages
* High quality products
* Products are made to measure
* Staff is motivated
* Storage costs are very low

Disadvantages
* High costs of production
* Skilled labour needed

Characteristics
* General, all-purpose machinery.
* Products are generally capital goods.
* One task must be completed before the next may commence.
* Customers give specifications.
* Production processes are seldom repeated.
* Workers must be highly skilled.
* Control of production is simple.

Batch production

Characteristics
* Falls between mass production and jobbing.
* One batch of products must be completed before work on the next one may begin.
* Customers give their specifications.
* Similar products produced on a batch basis, in large quantities.

Advantages
* Greater flexibility in terms of quantity produced, factory layout and manufacturing process.
* Can adjust to changes in demand.
* Less time wasted during machinery-breakdowns.
* Less expensive machinery.

Disadvantages
* Products take longer to produce.
* Larger quantities of semi-finished goods must be kept, hence increasing stockpiling costs.
* Cost per unit is generally higher.
* Careful planning needed to use this method effectively

Factory layout

Advantages of a proper factory layout

For workers
* Less exertion
* Less handling
* Happier and more productive in pleasant working conditions
* Fewer accidents

For Company
* Less working capital required
* Less money invested in stock
* Increase in factory safety
* Easier production control
* Lower labour, maintenance and transport costs
* High production yield
* Fewer labourer; fewer salaries and wages to pay

Requirements of a good factory layout

* Practical and economical
* Complies with government safety regulations
* Adaptable
* Promote workers' health
* Maximum space (vertical and horizontal) utilised
* A logical, consecutive process
* Materials have to travel the shortest possible distance.

Factory plant and machinery

Types of machinery

* Standard machines are built on a broad scale and are easier to maintain. They are used for batch production and jobbing.
* Specialised machines are built to specific requirements and are difficult to resell. They are used for mass production.

Factors to consider when purchasing machinery

* Lifespan
* Training that workers might require
* Availability of replacements
* Effect on factory layout
* Cost of purchase and maintenance
* Resale value
* Utilisation period per day
* Whether or not it can be utilised economically
* Rate of production
* Accuracy
* Availability of parts
* Rate of Lun

Maintenance

* Remedial maintenance -- complete overhaul when machinery breaks down
* Preventative maintenance -- minor or major repair to prevent breakdown
* Conditional maintenance -- inspection of condition

Product specification and methods of production

Product specification refers to anything which describes how a product will be manufactured.

Product planning and control

Advantages of efficient planning

For the supplier of raw materials
* Assured of a continued relationship with the factory
* Assured of regular orders from the factory

For the dealer
* Regular supply at a reasonable price
* Assured against having to search for suppliers all the time
* Usually assured of a certain quality, quantity and timeous and correct delivery
* Costs reduced

For the worker
* Job satisfaction is promoted.
* Healthy and safe working environment
* May result in improved wages or salaries
* Knowledge of what is expected

For the consumer
* Regular supply at right place and time
* Lower prices due to reduced production costs

Quality control

This is a system for determining at which points in the production process deviations and deficiencies emerge.

How to go about setting quality control
* Workers and inspectors must be made well aware of the prerequisite standards, and tolerances must be set.
* A suitable number of inspection points must be decided upon.
* Reliable testing and inspecting measures must be used.
* A suitable number of inspections per inspection point must be decided upon.

Advantages of quality control
* Dealers and customers are assured of the quality of the goods that they are purchasing.
* It can serve as a reliable basis for wage incentive schemes.
* Workers are encourage to continue to produce goods of a certain standard.
* Production costs can be lowered.
* It can lead to improved product design and quality.

Work study (time and motion only)
* Work study is a scientific measure of working methods, with the aim of finding more effective methods, machinery and materials, standardising them and determining a standard time for every method.
* Method study analyses all working methods and the organisation of machinery with a mind to finding more effective production methods.
* Work measurement is an evaluation of exactly how long it takes suitably skilled workers, labouring at maximum tempo (without adversely affecting health) with standard and according to stipulated requirements, to complete a given task.

Safety measures

* Hygiene requirements for workers
* Firewalls dividing rooms and other parts of the factory
* General safety and security
* Environmental conservation
* Flammable materials stored underground
* Availability of fire-fighting equipment
* Two exits in every room
* Fire escapes
* Structural safety of walls, floors and roofs
* Protection against machinery

Production costs

Functions of a cost accountant

* Consulting with the chief accountant to come to a decision on the spending of fixed and working capital so as to obtain an optimum return
* Investigating deviations from set standards and making corrective recommendations
* Compiling a comparison between the different production methods and presenting it to management
* Bookkeeping for all manufacturing expenditure and costs
* Analysing cost components
* Calculating cost price so that a selling price may be set

Why cost is important to the consumer

* The consumer has limited means or buying power.
* The consumer will benefit from a lower selling price.
* The consumer will benefit, too, in a market where supply and demand forces prices down.
* Competitive prices of substitute goods also benefit consumers.

Why cost is important to the manufacturer

* Provides management with information for decision-making
* Helps to determine the break-even point
* Determines the cost of raw materials, labour and other manufacturing costs for each component and completed product
* Makes easier the adjustment of the selling price for the purposes of competition
* Allows management to analyse unit production costs
* Determines safety margins in production

Cost components
o Direct raw material costs -- costs of raw materials used to make a specific product.
o Direct labor costs -- costs of labor used to make a specific product.
o Overheads -- costs that cannot be charged directly to a specific product.
o Fixed overheads -- stable costs that occur regardless of whether or not goods are being produced. These are allocated according to the number of machine hours.
o Variable overheads -- changeable overhead costs that vary according to the number of goods produced. These are allocated according to the number of labor hours.
o Indirect raw material costs -- costs of raw materials whose role in the manufacturing of a product cannot be easily determined.
o Indirect labor costs -- costs of labour that cannot be charged to a particular product.
* Primary production costs = direct labour + direct raw materials
* Overhead expenses = fixed overheads + variable overheads
* Total production costs = primary production costs + overhead expenses