MANAGERIAL

ECONOMICS
Week 11
Muhammad Rizky Ramadhan, BBus., MITHM
Understanding the
Competitive
Advantage through
Production Cost
Reduction
 Production or operational costs in
industrial systems play an important
role, because they create a competitive
advantage in competition between
industries in the global market

70% - 90% of the proportion of production costs

comes from the total cost of overall sales, so
reducing production costs through increasing
efficiency will make the selling prices set by
producers more competitive with constant
marketing and finance and can increase Net Profit
 And if production costs have been reduced, the set
selling price can also be lowered, so that at the same
level of quality and a more competitive selling price,
it will increase sales.`

If the strategy carried out continuously

(continuous cost reduction improvement)
will bring the industry to a competitive
advantage in the global market
The Law of Diminishing
Return
The law that states that the additional output is reduced by adding
one unit of variable input, when the output has reached its maximum.

Applicable Assumptions
• There is only one variable input unit, the other inputs are fixed.
• The technology used in the production process has not changed.
• The nature of the production’s coefficient is arbitrary.

The Law of Diminishing Returns can be divided into three

stages, namely:
• total production with increasing returns
• total production with decreasing returns
• declining total production
 THE PRODUCTION PROCESS

FIGURE 7.5 Production Function for Sandwiches

10 of 33
 KURVA PRODUKSI JANGKA PENDEK
Definition
The production curve that shows the relationship between input and outputs

Relationship between TP, MP and AP

• Marginal product (MPL) is the slope of the Total product which means:

• If Total product (TPL) will increase then MPL > 0, will be maximum when
MPL = 0 and will decrease when MPL < 0

• Average product (APL) will increase when MPL > APL and will decrease when
MP < AP and when MPL = APL then APL will be maximum
PRODUCTION PHASES
 EXERCISE

Suppose that an agricultural business has labor

data and the level of production to be achieved for
each amount of labor used is as follows:
 Labour Total Production
1 1
2 3
3 6
4 10
5 15
6 19
7 22
8 24
9 24
10 22

A. Calculate the MP, AP Maximum

B. Draw the TP, MP, AP curves and determine at which workforce can produce the most
efficient production? Show using curve
Balance of
Production
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The Relationship Between Marginal Product (MP) and
Marginal Rate of Technical Substitution (MRTS)

If the balance of producers expressed by:

- PL/PK = - δK/δL = MRTSLK = MPL/MPK,
therefore :

MPL/MPK = PL/PK or MPL/PL = MPK/PK

THE EXPANSION PATH
 Upper Ridge Line

M
K K
A
N
Lower Ridge
B
Line

C D

0 L 0 L

Titik B sampai C adalah daerah produksi yang ekonomis (relevance range of production)
karena memiliki MRTSLK yang negatif. Namun jika dari titik B ke A atau C ke D menunjukkan
produksi yang tidak rasional/ekonomis karena memiliki MRTSLK yang positif.
 Return to Scale

❑ Berkaitan dengan hubungan antara perubahan output dengan perubahan hanya pada
satu jenis input yang digunakan atau didefinisikan sebagai prosentase perubahan output
sebagai akibat prosentase perubahan input tertentu.

❑ Adatiga jenis Return to Scale

• Increasing Return to Scale : % ∆ input < % ∆ Output
• Constant Return to Scale : % ∆ input = % ∆ Output
• Decreasing Return to Scale : % ∆ input > % ∆ Output
RETURN TO SCALE
Cobb-Douglas’ Production Function

Where:
Q : Output yang diproduksi
L : input Tenaga Kerja
K : Input Modal
A : Tingkat Teknologi
Α dan β : Elastisitas tenaga kerja dan modal
 REMEMBER!

THE CONCEPT OF
PRODUCTION COST
THEORIES OF COST (TEORI BIAYA)
All the expenses in a form of payment for skills of the
labours, capital, or the building which self-owned

IMPLICIT COST

Production Cost
EXPLICIT COST

Semua pengeluaran yang dilakukan oleh perusahaan

untuk memperoleh input yang akan digunakan untuk
memproduksi output All the expenses in a form of money or
budget to get some inputs
All the expenses that used by a firm to gain the input
which later will be utilized in producing the outputs
 Other Costs

• Opportunity cost is the value of economic resources including production factors in the
best alternative use, for example wood, if the wood material produces goods then there is a
lost opportunity to produce other goods with the wood, the opportunity value is lost This is
an opportunity cost that is reflected in the prices of factors of production in the market.

• Historical costs are costs incurred by the company when buying production factors
(inputs), for example, the price of cement at the time of purchase and when it is used will
experience a price increase in the sense of a different purchase value.

• Incremental costs are costs that arise as a result of decisions that have been made (can be
fixed costs or variable costs, or both.

• Relevant costs (incremental costs) are costs that will be charged when a decision has been
made.
 Types of Short Run Production Cost Analysis

TC
• Biaya Tetap Total (Total Fixed Cost),
TFC = f (Constant). TVC

• Biaya Variabel Total (Total Variabel Cost),

TVC = f (output atau Q). TFC

• Total Cost (Total Cost), TC = TFC + TVC Q

Short Run Production Cost Analysis

Biaya Produksi
1. Average Fixed Cost, AFC = TFC/Q
MC
2. Average Variabel Cost, AVC = AVC/Q AC
AVC
3. Average Cost,

AC =
TFC
4. (Marginal Cost); MC = ∆TC/ ∆Q Q
 The Relationship between Short Run
Production and Short Run Costs

• If the rate of wage of employees stated as w per unit on the labours, therefore to produce the output
in an amount of Q the firm needs to spend TVC around:

TVC = w x L

• If the price of input’s capital stated as r per unit on the input’s capital, thus to produce the output in
an amount of Q the firm needs to spend TFC around

TFC = r x K
 The Relationship between Short Run
Production and Short Run Costs

The total cost (TC) in short run can be illustrated as Short Run Production which uses Labour (L) as a
variable input alongside with the wage rate around w per unit labour, the capital input, K with the price
of input as r per unit capital and therefore can be shows as followed:

TC = wL + rK
The Relationship between Production Curve and Cost
Curve
Hubungan Produksi dan Biaya (The relationship of Production and Cost)

• Secara grafik, fungsi biaya merupakan invers (kebalikan) dari fungsi produksi
• Graphically, the cost function is the inverse of production function

• Pada saat Kurva TP mencapai titik belok maka MPL maksimum dan pada fungsi biaya ketika
kurva TVC mencapai titik belok maka fungsi MC mencapai minimum. (When the TP curve reached
the inflection point thus MPL Max. and the cost function when TVC curve reached the inflectiopn
point thus MC Min)

• Pada saat Kurva TP mencapai titik singgung dari sumbu origin maka kurva APL mencapai
maksimum dan APL maksimum=MPL sementara itu pada fungsi biaya, AVC mencapai minimum
pada saat AVC minimum = MC (When the TP Cuce reach the tangent point from the origin then APL
curve reach its maximum and APL max = MPL. Meanwhile, on the Cost Function, AVC reache its
minimum when AVC minimum = MC)
Mengapa dalam proses produksi jangka pendek kurva MC, AVC dan AC berbentuk
huruf “U” ?
Why in the short run production the MC, AVC, AC curve always formed “U”

Jawaban (Answer)

Karena dalam jangka pendek berlakunya The Law Of Diminishing Return.

 LONG RUN AVERAGE COST (LRAC)
• Semua input yang digunakan bersifat input variabel sehingga tidak ada lagi biaya tetap
sehinggaTC = TVC
All the inputs used are variable inputs therefore there is no fixed costs, so we can imply
that TC = TVC

• Untuk memproduksi setiap tingkat output ada satu metode terbaik yaitu dengan Least Cost
Combination (LCC)
• To produce every level or rate of outputs there is one method which appropriate and it uses Least Cost
Combination (LCC)

• Kurva Long Run Average Cost (LAC) berbentuk “U” karena adanya Economies of Scale dan
Diseconomies of Scale
• The LAC formed U because of the presence of Economies of Scale and Diseconomies of Scale
LONG RUN TOTAL COST (LRTC / LTC)
LONG RUN AVERAGE COST (LRAC / LAC)
 LONG RUN AVERAGE COST (LAC / LRAC)

• The production process that no longer uses fixed inputs, all production costs are
variable.
• Long-term production cost behavior; decisions on the use of variable inputs by
the company in the short term.
• Long-run cost function; Long-run average cost (LAC), long-run marginal cost
(LMC), which is obtained from long-run total cost (LTC)
 LMC
C
Economies of scale LAC

Diseconomies of scale

0
Q
Kurva LAC menurun :
Economies of Scale : Penghematan biaya Kurva LAC menaik :
• Decreasing Cost Diseconomies of Scale : Pemborosan biaya
• Increasing Return to Scale • Increasing Cost
• Decreasing Return to Scale
● Long-run average cost (LRAC), shows the minimum average of the
combinatons of inputs used in producing the certain level of output
rates with the least cost combination

SAC1 LMC SAC 10 LAC

SAC2 SAC 9
SAC 3
SAC 8
SAC 4 SAC 7
SAC5 SAC 6

0 Q
• Economics of scale Production activities in the long run are said to be of economies of
scale if the increase in production causes the average production cost to be lower.
From the LRAC figure, this condition of economies of scale is shown by the area from
A to B or from QA to QB. Factors that can lead to economies of scale include: 1.
Specialization of production factors 2. Reduction of the price of production factors 3.
Allows for producing by-products 4. Encouraging the development of other
businesses.

• Diseconomics of scale Production activities in the long run are said to be non-
economy of scale if the increase in production causes the average production cost to
be higher. This uneconomic scale is shown by the region from B to C or from QB to
QC. This non-economy of scale can occur, usually when the company gets bigger, so
the activities and organization of the company become more complex. Policy and
decision-making are becoming increasingly rigid, and take a long time. This situation
causes an increase in costs because the company is no longer efficient.
Grazie