Module 3 - PRODUCTION &

COST
In this lesson:
Identify the Inputs of Production
Learn the Production Function
Differentiate the Total Product, Marginal
Product and Average Product
Analyze the Law of Diminishing Returns
Determine the Three Stages of Production
Understand the Cost Analysis
Ascertain knowledge in Profit Maximization
What are inputs of production?
Inputs of production are any resources used to create goods and services.
Examples of inputs include labor (workers’ time), fuel, materials, buildings,
and equipment.

1. Labor input is the time

people spend working to
produce goods and
services.
Other inputs to production
2. Capital is the property used by businesses to produce goods and services.
It includes both physical assets and intellectual property.
Examples:
3. Material inputs are goods that are used in making other products. 
They include both raw materials and manufactured products.
Examples:
4. Purchased services inputs are services purchased from other businesses
in other industries or sectors.
Examples:
What Is Production Function?
https://www.wallstreetmojo.com/production-function/ 
The production function is a mathematical equation determining the
relationship between the factors and quantity of input for production and the
number of goods it produces most efficiently. It answers the queries related
to marginal productivity, level of production, and cheapest mode of
production of goods.
Four major factors of production are – entrepreneurship, labor, land, and
capital. Using the above four factors, every manufacturing plant converts
inputs into outputs. Hence the factors necessarily determine the
production level of goods to maximize profits and minimize cost.
Therefore, the production function is essential to know the quantity of
output the firms require to produce at the said price of goods. It
determines the output and the combination inputs at a certain capital and
labor cost.  

Production Function Graph

This graph shows the short-run
functional relationship between the output
and one input, i.e., labor, by keeping other
inputs constant. The X-axis represents the
labor, and the Y-axis represents the
quantity of output.
 The curve starts from the origin 0,
indicating zero labor. It gets flattered
with the increase in labor. One can
notice that with increasing labor, the
level of output increases to a level.
Further, it curves downwards. It is
because the increase in capital stock
leads to lower output as per the
Formula:
The general production function formula is: capital’s decreasing marginal product. In
Y= y(K, L),  short, the short-run curve slopes
Where:
Y - is the output quantity, 
upwards till the product reaches the
L - is the labor used, optimum condition; if the producers add
K is the capital invested to produce the goods.  more labor further, the curve slopes
y - is a mathematical function depending upon the
input used for the desired output of the downwards due to diminishing marginal
production. product of labor. 
The Law of Diminishing Marginal Productivity or Return
For example, consider a farmer using fertilizer as an input in the process for
growing corn. Each unit of added fertilizer will only increase production return
marginally up to a threshold. At the maximum level, the added fertilizer does
not improve production and may harm production.
Total Product, Average Product, and Marginal Product

Theory of Production
In theory of production, we always looked at the costs to produce certain
goods. But how do we know how to best allocate the money necessary to
purchase the resources in the first place? To do that, we rely on the theory of
production, which allows firms to figure out how much of which resources they
need to acquire. To do this, we look at three different factors: the total product,
the average product, and the marginal product.
• Total product is the total volume or amount of final output produced by a firm
using given inputs in a given period of time, 
• average product  measures the average output of products for each unit
variable input, and 
• marginal product  is the change in output when one unit of input of one
variable is added keeping the other variables constant.
Total Product
The total product can be defined as the total volume or amount of final output
produced by a firm using given inputs in a given period of time.
Total product calculation helps firms to understand how much input can be
obtained by using a single input while keeping other inputs constant. Therefore,
they can measure the required input to get the desired amount of output.
Knowing this helps the producers in many ways. They cannot only organize their
production levels depending on the total output, but they can also use the
optimal amount of the required input when needed. This can reduce the
wastage of resources and can let producers use the optimum number of raw
materials.
Total Product Formula is TP= AP*L

Where:
AP= product/ labor unit
L= Labor
Average Product
Average product measures the average output of products for each unit
variable input. Therefore, it shows the number of inputs required to produce a
certain amount of product output.
Usually, the productivity of input increases with an increase in the average
product. To calculate the average product, the total product value of the
variable input must be known. Once the total product value is obtained, and it is
divided by the number of inputs invested, the average product value can be
obtained.
Average Product Formula: AP= TP/ L
Example:
Suppose a producer of men’s shirts has four employees, and, in a week, he gets 100 shirts
ready. Therefore, the average product produced by the producer is 100/4 = 25
Now the producer needs to increase the production due to a huge order and so he recruits 26
more employees. Now he sees that weekly production has reached 780. So, the average
product has increased to 780/30 = 26.
Marginal Product
Marginal product is the change in output when one unit of input of one
variable is added keeping the other variables constant. In simpler words, it
shows how many additional output products will be produced for the addition
of one unit of input, like labor, materials, or overhead.
The marginal product calculates the total change in output for an additional
amount of input. The idea behind calculating marginal product is to isolate
each input and check the output.
The following example would make this concept clear.
Marginal Product Formula: MP= Changed Output - Previous Output
Example:
Suppose, the shirt maker produces 6 shirts a week alone. When he recruits
another person, the total output changes to 11. So, for each additional input,
the change in output is 5, which is the marginal product.
Three Stages of Production
Economists recognize three distinct stages of production, which are defined by
a concept known as the law of diminishing marginal returns. This law holds
that as you add more workers to the production process, output will increase,
but the size of that increase will get smaller with each worker you add. At some
point, if you keep adding workers, your output may even start shrinking. The
idea of the three stages of production helps companies set production
schedules and make staffing decisions.

In economics, the three stages of production are:

1. increasing average product production,
2. decreasing marginal returns and These stages of production apply to short-term
3. negative marginal returns. production of goods, with the length of time
spent within each stage varying depending on
the type of company and product.
During the first stage of
production, the total product
curve always has a positive
slope, with marginal product
always being initially greater
than average product. However,
the two product lines meet and
become one as the first stage
ends. Stage two of the
production curve typically
features decreasing positive
marginal returns, before
becoming negative as it enters
stage three.
 Remember the formula in Marginal Product  MP= Changed Output - Previous Output

For additional info, watch the video clip entitled:

Diminishing Returns and the Production Function

Cost Analysis
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Cost analysis is a helpful tool to enhance project management and predict
potential profits for a company. Cost analysis is used to calculate how much
money a project can generate compared to the project's overall costs. Learning
how to calculate a cost analysis ratio can help you determine the cost and profit
from a project and develop a strategic plan for its finances.
What is cost analysis?
Cost analysis, also known as cost-benefit analysis, is the process of
calculating the potential earnings from a production or project, then subtracting
the total cost of production or project. It offers a prediction of the profit gained
from a project and compares the cost of the project versus the estimated
financial benefits of the project. Many finance professionals use cost analysis in
their practice to show clients their potential profits from a project.
Importance of Cost Analysis

1. Helps decision-making
Cost analysis allows professionals to make decisions regarding future projects
because they can weigh the outcome of the project against the total cost of the
project. If the cost of the project is higher than the predicted earnings,
professionals can make the necessary changes to the project to increase the
earnings or lower the cost.
2. Keeps stakeholders involved
Cost analysis ensures that companies involve stakeholders in the decision-
making process. Stakeholders are a necessary part of business operations
because they contribute to a company and take interest in projects, so it's
important that companies engage stakeholders in project data. Sharing cost
analysis information can provide stakeholders with the information they need to
make informed decisions about budgeting and financial strategy.
3. Solves problems
Cost analysis can help identify financial problems and find solutions. If a
company is experiencing difficulty in project management, it can use cost
analysis to maintain organization and gain a deeper understanding of a
company's finances and future projects. Performing regular cost analysis
reviews can help you identify which factors impact a project's profitability
and address those factors directly.

How to Calculate Cost Analysis

1. Determine the reason you need a cost analysis
The way you use a cost analysis can vary depending on why you need a
cost analysis done. Determine why you need a cost analysis so that you have
a better idea of what variables you can use. For example, if you are doing a
cost analysis so that you can create a budget for a project, you might pull
previous financial information related to budgets.
2. Evaluate cost
The next step is to evaluate all of the costs associated with a project. It may
be useful to write all the costs out in a list so that you have it available for
future steps. Be sure to think of any unexpected costs associated with the
project, and also consider how the costs might change over time. Here are the
examples of cost to consider when evaluating cost:
o Direct cost: This is the cost associated with each product variable, like product type,
customer, service or activity.
o Indirect cost: These expenses are not directly associated with the project, but the
company still needs to include them in the budget, and can include rent, utilities and
administrative expenses.
o Real cost: This is the cost associated with the actual production of a project, like labor and
material costs.
o Tangible cost: This is the cost that relates to supporting a project, like purchasing tools
and paying employees.
o Intangible cost: Factors that impact the outcome of a project, like changes in production
levels or decreases in customer satisfaction, are known as intangible costs.
3. Compare from the previous projects
For the next step, compare your current cost analysis project from the
previous projects. You can use this information as to identify similar costs and
calculations that you can include in your analysis. Comparing your data to other
cost analysis projects can ensure that you have enough information to develop a
realistic understanding of your costs and income.

4. Define all stakeholders

Identifying the stakeholders for the project is important so that you calculate
an accurate cost analysis. Stakeholders are an individual or group that have an
interest in the project. They might invest money in the project or take part in
developing the project. The outcome of the project's profit impacts stakeholders,
which makes it essential for stakeholder information to be included in cost
analysis.
5. List the potential benefits
Next, it's time to list the potential benefits of a project, which refers to how much
money the project generates. Benefits can differ based on the type of project being
analyzed, though to get an accurate estimate of benefits, be sure to consult with
stakeholders and financial analysts on how to value the project benefits.
6. Subtract the cost from the outcome
The next step involves finding your cost analysis ratio is subtracting the total number of
costs from the project's estimated benefits. For example, if a project's total costs are
100,000 and the benefits are 250,000 then 250,000 -100,000=150,000. If you have
multiple different scenarios for how much profit a project could generate, you can produce
several cost analysis ratios.
7. Interpret your results
Once you have the value of your cost analysis, it's important to interpret the results so
that you can decide if you want to pursue the project. Generally, if your results meet the
goal of the income you want to earn from the project, then it's a good idea to pursue the
project. If the cost analysis shows that you won't bring meet your goal, then consider
lowering the cost of the project or find ways to raise the benefits.
Activity 4 - Cost Analysis: A Case Study
Fit to Wear Clothing Company
Cost Analysis for 2023

Fit to Wear Clothing Company wants to determine if they should launch a new clothing line by next year.
They decide that a cost analysis would offer them insight into how much they would earn from the project,
which can help them make the decision to pursue the clothing line or not. They have decided that their goal is
to generate over P1,000,000 next year.
Their accountant sits down and writes out all costs associated with the new clothing line. They determine
that their direct costs would total 75,000, their indirect cost totals 50,000, their real cost totals 350,000, their
tangible cost totals 80,000, and their intangible cost totals 100,000.
Next, they pull information from previous clothing lines to analyze financial similarities. They find that their
clothing line from two years prior has similar costs, so they know to analyze how well they profited from that
clothing line sale.
Their next step involves determining all the stakeholders within their upcoming year clothing line. They
identify five separate stakeholders, and they know to make the stakeholders aware of the cost analysis. They
also consult with the stakeholders to get advice on maximizing the benefits while minimizing cost.
To finish their cost analysis, they add up all of their costs, then they subtract the total number of costs from
the benefits.

Question: Based on the given data, compute the cost analysis of Fit to Wear Clothing Company and
decide whether you pursue the project or not.
Profit Maximization
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Profit maximization is a process business firms undergo to ensure the

best output and price levels are achieved in order to maximize its returns.
Influential factors such as sale price, production cost and output levels are
adjusted by the firm as a way of realizing its profit goals.
In business, profit maximization is a good thing, but it can be a bad thing
for the client if, for example, lower-quality materials and labor are used or if
the business decides to raise the prices for executing projects, all in pursuit
of profit maximization.

Let’s now explore some of its advantages and disadvantages.

Advantages of Profit Maximization

1. Economic survival: Profit is vital for the survival of any business

2. Measurement standard: Profits are the right measurement of the
viability of a business model. In the absence of profits, the business
loses its key goal and incurs a direct risk to its survival.
3. Social and economic welfare: In a business, profits demonstrate
proficient use and allotment of resources. Resource allocation and
payments for land, labor, capital and the organization lends itself to
social and economic welfare.
Disadvantages of Profit Maximization
1. Time value of money is ignored: The formula is based on the idea that
the higher the profit, the better the proposal, but what about its
timing? In finance, when considering present value, we know that cash
now won’t have the same value in the future.
2. Attention not paid to risk: In the pursuit of profit, risks involved are
ignored, which may prove unaffordable at times, the fact that the
higher risk directly affects the survival of a business.
3. Ignores quality: The most challenging part of profit maximization as a
goal is that it neglects the intangible benefits such as quality, image,
technological advancements etc. However, the input of intangible
assets in generating value for a business is not worth neglecting, as
they indirectly create assets for the organization.
Next meeting…QUIZ
[Coverage Module 2 and 3]