UNIT 6

PRODUCTION AND COSTS

Lead-in

Fill in the spidergram with the words associated with Taxation and Audit.

Production and

Costs

Discuss the following questions.

1.What types of costs do you know?

2.Who manages production costs at enterprises?

3.How production costs affect the final cost of the goods?

4.How to reduce production costs?

5.Which production costs prevail in petroleum industry?

Exercise 1. Read the text and do the exercises.

Production and Costs

Whether they are film producers of multimillion-dollar epics or small firms that market a single product, suppliers face a difficult task. Producing an economic good or service requires a combination of land, labour, capital, and entrepreneurs. The theory of production deals with the relationship between the factors of production and the output of goods and services. The theory of production is generally based on the short run, a period of production that allows producers to change only the amount of the variable input called labour. This contrasts with the long run, a period of production long enough for producers to adjust the quantities of all their resources, including capital.

The Law of Variable Proportions state that, in the short run, output will change as one input is varied while the others are held constant. The Law of Variable Proportions deals with the relationship between the input of productive resources and the output of productive resources and the output

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of final products. The law helps answer the question: How is the output of the final product affected as more units of one variable input or resource are added to fixed amount of other resources? Of course, it is possible to vary all the inputs at the same time. Economists do not like to do this, however, because when more than one factor of production is varied, it becomes harder to gauge the impact of a single variable on total output. When it comes to determining the optimal number of variable units to be used in production, changes in marginal product are of special interest.

There are three stages of production — increasing returns, diminishing returns, and negative returns — that are based on the way marginal product changes as the variable input of labour is changed. In stage one, the first workers hired cannot work efficiently because there are too many resources per worker. As the number of workers increases, they make better use of their machinery and resources. This results in increasing returns (or increasing marginal products) for the first five workers hired. As long as each new worker hired contributes more to total output than the worker before, total output rises at an increasingly faster rate. This stage is known as the stage of increasing returns. In stage two, the total production keeps growing, by smaller and smaller amount. This stage illustrates the principle of diminishing returns, the stage where output increases at a diminishing rate as more units of variable input are added. The third stage of production begins when the eleventh worker is added. By this time, the firm has hired too many workers, and they are starting to get in each other's way. Marginal product becomes negative and total plant output decreases.

Measures of Costs

Because the cost of inputs influences efficient production decision, a business must analyze costs before making its decision. To simplify decision making, cost is divided into several different categories.

The first category is fixed cost — the cost that a business incurs even if the plant is idle and output is zero. Total fixed cost, or overhead, remains the same whether a business produces nothing, very little, or a large amount. Fixed costs include salaries paid to executives, interest charges on bonds, rent paymentson leased properties, and local and state property taxes. Fixed costs also include deprecation, the gradual wear and tear on capital goods over time and through use.

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Another kind of cost is variable cost, a cost that changes when the business rate of operation or output changes. Variable costs generally are associated with labour and raw materials. The total cost of production is the sum of the fixed and variable costs.

Another category of cost is marginal cost – the extra cost incurred when a business producers one additional unit of a product. Because fixed costs do not change from one level of production to another, marginal cost is the perunit increase in variable costs that stems from using additional factors of production. The cost and combination, or mix, of inputs affects the way businesses produce. The following examples illustrate the importance of costs to business firms. Consider the case of a self-serve gas station with many pumps and a single attendant who works in an enclosed booth. This operation is likely to have large fixed costs, such as the cost of the lot, the pumps and tanks, and the taxes and licensing fees paid to state and local governments. The variable costs, on the other hand, are relatively small. As a result, the owner may operate the station 24 hours a day, seven days a week for a relatively low cost. As a result, the extra wages, the electricity, and other costs are minor and may be covered by the profits of the extra sales.

Measures of Revenue

Businesses use two key measures of revenue to find the amount of output that will produce the greatest profits. The first is total revenue, and the second is marginal revenue. The total revenue is the number of units sold multiplied by the average price per unit. The marginal revenue is determined by dividing the change in total revenue by the marginal product. Keep in mind that whenever an additional worker is added, the marginal revenue computation remains the same. If a business employs, for example, five workers, it produces 90 units of output and generates $ 1,350 of total revenue. If a sixth worker is added, output increases by 20 units, and total revenues increase to $ 1,600. To have increased total revenue by $ 300, each of the 20 additional units of output must have added $ 15. If each unit of output sells for $ 15, the marginal or extra revenue earned by the sale of one more unit is $ 15 for every level of output. Marginal revenue can remain constant but businesses often find that marginal revenues start high and then decrease as more units are produced and sold.

Marginal Analysis

Economists use marginal analysis, a type of cost-benefit decision making that compares the extra benefits to the extra costs of an action. Marginal

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analysis is helpful in a number of situations, including break-even analysis and profit maximization. In each case the costs and benefits of decisions that are made in small, incremental steps. The break-even point is the total output or total product the business needs to sell in order to cover its total costs. A business wants to do more than break even, however. It wants to make as much profits as it can. But, how many workers and what level of output are needed to generate the maximum profits? The owner of the business can decide by comparing marginal costs and marginal revenues. In general, as long as the marginal cost is less than the marginal revenue, the business will keep hiring workers. When marginal cost is less than marginal revenue, more variable inputs should be hired to expand output. The profitmaximizing quantity of output is reached when marginal cost and marginal revenue are equal.

(Garry Clayton) Exercise 2. Decide whether these statements are True (T) or False (F).

1.The theory of production deals with a period of production that allows producers to change the amount of labour used.

2.The law helps answer the question: How is the output of final product affected as more units of one variable input or resource are added to fixed amount of other resources?

3.In stage one of production the more workers are hired the less are the returns.

4.When an additional worker is added, the marginal revenue computation changes according to the stage of production.

5.When marginal cost is less than marginal revenue, more variable inputs should be hired to expand output.

Exercise 3. Study the explanation of special terms.

output (n) – the amount of goods or services produced by a person, machine, factory, company, etc.

input (n) – ideas, advice, effort, o\ money that you put into something to help it succeed

factor of production – something that is needed to produce a particular product

diminishing return – the idea that a point can be reached where the advantage or profit you are getting, stops increasing in relation to the effort you are making

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marginal (аdj) – relating to a change in a cost, value, etc. when one more thing Is produced, one more dollar is earned, etc.

costs (n) – money that a business or an individual must regularly spend fixed costs – costs to a business that do not change when the amount of goods or services produced does

incur (v) – if you incur a cost, a debt, or a fine, you do something that means that you lose money or have to pay money

overhead costs – costs not directly related to a particular product or service, but related to general costs for buildings, equipment, etc.

interest (n) – an amount paid by a borrower to a lender, for example to a bank by someone borrowing money for a loan or by a bank to depositor charges (n) – an amount of money paid for services or goods

rent payment – money paid for the use of a house, office, etc.

lease (v) – to give somebody the right to use something for a particular period of time in return for payment

depreciation (n) – decreasing in value over a period of time

variable costs – costs that change when the amount of something produced changes

rate of operation – capacity of work done by a company or machine marginal cost – the extra cost of producing one more of something self-service (n) – a self-service shop, restaurant, etc. is one in which customers get the goods themselves and then go and pay for them

lot (n) – an area of land on which nothing has been built and which may be available to rent, or build on

revenue (n) – money that a business or organization receives over a period of time, especially from selling goods or services

break-even (adj) – when a company is neither making a profit or a loss

Exercise 4. Give English equivalents to the following words and expressions.

фиксированные затраты; самообслуживание; безубыточный; норма загрузки производственных мощностей; доход, выручка; переменные издержки; накладные расходы; износ; сокращающийся доход; фактор производства.

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Exercise 5. Choose the appropriate word or expression from the box to complete the following sentences.

1.Commercial ______ have decreased significantly since their peak in 1997.

2.The East Moline foundry has been operating at less than 50 % capacity and has _______ significant operating losses.

3.The _____ is the added output resulting from employing one more worker.

4.Their retail branches are a _______, so the more business they put through them the better.

5.Delay in construction could increase _______ significantly.

6.Chrysler might run out of money to pay _______ on its bonds.

7.The proposed site of the factory may lead to _______ of property value in the immediate vicinity.

8.The local authority _______ him the property.

Exercise 6.  Discuss the following with your partner before listening.

Price in not only the cost of something. Every purchase has a hidden cost. What do you think this is?

Listen and choose the best answer for each question.

1.What is opportunity cost?

a)Something you have to give up in order to have something else.

b)Something a company can charge people for goods or services.

d)Something that companies pay when they first start business.

2.What could be the opportunity cost of watching television?

a)Getting sore eyes.

b)The cost of buying a television.

c)Not sunbathing in the garden.

3.What is the opportunity cost of Alice’s decision?

a)₤ 3,000

b)₤ 39,000

c)₤ 13,000

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Exercise 7. Discuss the following points.

1.Comment on the statement: Profit is maximized when the marginal costs of production equal the marginal revenue from sales.

2.Explain the use of marginal analysis for break-even and profit maximizing decisions.

3.Many oil-processing plants shift workers to maintain operations. How do you think a plant's fixed and variable costs affect its decision to operate around the clock?

Exercise 8. Prepare presentation on the following topics.

1.Costs in the petroleum engineering

2.Costs in the oil and gas exploration

3.Costs in the oil and gas transportation

4.Costs in the pipeline constructions.

Exercise 9. Read the article and do the exercises.

The Benefits of Being Small: Balancing Economies of Scale Against

the Advantages of Intimacy Is a Delicate Task

In the 1970s the British economist E.F. Schumacher coined the phrase "small is beautiful." The expression focused on a design question. As companies become larger and more complex, can they restructure to retain the human benefits of smaller companies? Schumacher believed that they could not. They would have to reduce in size and change their command structure. His argument was simple. As a company adds more people in more locations the sheer task of holding this lot together becomes an end in itself. The economic advantages of scale will be eroded by the disadvantages of a loss of intimacy.

Schumacher was largely ignored outside Europe. At the time a prevailing view was that large companies could be very profitable if structures were crystal clear and rational. Through these means human error or deviance could be minimized. One company was always quoted as the supreme example of the triumph of structure over deviance: International Business Machines, arguably the greatest exponent of machine-like precision through command and control structures. However, in 1993 IBM lost $5bn (£ 5.6bn). Forthoseon the inside, the collapse of the world's most successful computing

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company was stunning. At the time I taught on IBM's senior management programme at La Hulpe in Belgium and I could track the growing unease. Yet the IBM staff still believed that creative, structural solutions would save the day.

Managers largely ignored the evidence of paralysis at the top. They were part of the paralysis. The rest is history. Lou Gerstner, with no background in computing, was brought in to rebuild IBM. Seemingly, overnight half of the far-flung 450,000 devoted, loyal, programmed IBM-ers were banished. The rational model had been shown to be flawed. Since the 1990s various studies have reinforced the idea that 1,000 employees in one location is about the maximum size for any company if it is to retain the advantages of the economies of scale and minimize the human diseconomies arising from adding more people. IBM did clean out 50 per cent of its workforce – but controlling size was not the main way the company reinvented itself. Its most important decision was to offload its entire hardware and components manufacturing.

Outsourcing was its most spectacular strategy. In the latest McKinsey Quarterly, the logic and effect of outsourcing as a strategy and how it affected IBM are examined. The research question posed by the authors is: has outsourcing gone too far? The logic of outsourcing is that by shedding assets companies can concentrate on the interesting work. Employees are remotivated to develop product or services, discover solutions and be innovators or supply chain integrators. Liberation leads to an increased rate of return on invested capital The Journal provides sensible, practical insights into the sort of questions companies should ask before embarking on outsourcing. If internal suppliers can meet industry standards within a set time and present a competitive advantage, an internal solution may be preferable. If, as well, the internals are not readily substituted outside and are vital to the corporate culture and reputation, the company should resist outsourcing.

Conversely, if there are dramatic cost savings available from cheaper labour sources or the skills are hard to acquire or suppliers have greater productive capacity and higher levels of expertise and knowledge, the case for outsourcing is strong. Rarely is outsourcing an either/or decision. So the authors discuss a mixture of tactics in which the company gets the best from both sources, internal and external. They rightly question the general assumption that outsourcing is always best. One issue that the authors do not discuss is dependence. This is often critical.

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How dependent does a company become once it has transferred all its information technology processing to a supplier? Transferring staff is fine if the explicit and tacit knowledge is readily available elsewhere. It may be dangerous if it is not. By the mid-1990s IBM had redefined its core business as e-business services and solutions, research and design and semiconductor architecture and manufacturing and spun off its hardware and components manufacturing business. By 2000 it reported revenues of $ 8.09 bn. What does all this tell us? First, by outsourcing manufacturing IBM made possible a massive strategic shift.

Lesson: outsourcing is not just a tactic for transferring costs, or people problems. Second, IBM's leaders could not have known in 1994 how the company's future would evolve. This was not change based on a clear vision and a rational plan. Lesson: To outperform the competitors, companies must take risks, follow a shared hunch and tolerate ambiguity about the outcomes. Third, this transformation was achieved by relentless segmentation into smaller units.

Lesson: Schumacher's argument on the human diseconomies of size was valid. For innovation and creativity, free forming self-governing teams are essential. Small in this sense is beautiful.

(John W. Hunt, "Financial Times")

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Exercise 10. Answer the following questions.

1.What human benefits did Schumacher have in view when he coined the phrase "small is beautiful"?

2.Did other economists and industrialists share his opinion?

3.How did industrialists intend to minimize possible human error or deviance in a large company?

4.What other strategy besides controlling size did IBM use to reinvest itself in 1990s?

5.Was outsourcing strategy an efficient measure? What is the logic of this strategy?

Exercise 11. Put the sentences in the logical order.

A Yet the IBM staff still believed that creative, structural solutions would save the day.

B First, by outsourcing manufacturing IBM made possible a massive strategic shift.

C In the 1970s the British economist E. F. Schumacher coined the phrase "small is beautiful.

D Outsourcing was its most spectacular strategy.

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E They rightly question the general assumption that outsourcing is always best.

FSmall in this sense is beautiful.

GSchumacher was largely ignored outside Europe.

Exercise 12. Match up the words with their definitions.

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Exercise 13. Translate into English.

Сущность и структура издержек производства

Производство любого товара сопряжено с определенными затратами (издержками). Затраты материальных ресурсов и денежных средств, которые несет производитель на производство продукции, называются издержками производства.

Поскольку в рыночной экономике конечной целью производителя является получение прибыли, то издержки производства как один из ее ограничителей всегда находятся под его пристальным вниманием.

Следует различать издержки производства: а) прямые и косвенные; б) внешние и внутренние;

в) постоянные и переменные; г) краткосрочные и долгосрочные.

К прямым издержкам производства относятся те затраты по производству продукции, которые несет непосредственно производитель.

В экономической теории они получили название себестоимости. Ha предприятиях, где существует найм рабочей силы, они включают следующие элементы:

•сырье, основные и вспомогательные материалы;

•топливо и энергию;

•амортизацию;

•зарплату и отчисления на социальное страхование;

•прочие затраты.

Косвенные расходы по производству продукции несет государство. Это расходы на образование, медицину, спорт (финансируемые за счет государства) и др. Как правило, эти расходы обеспечивают производство рабочей силы на качественно новой основе и создают условия для нормального функционирования производства. Основным источником погашения этих затрат является прибавочный продукт, изымаемый государством в виде налогов и обязательных платежей. Поэтому в основе цен на товары и услуги лежит не себестоимость, а стоимость, т. е. общественные затраты на производство продукции.

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