Cost is the amount that a person or a firm must give up to get something. Besides, it is the value of sacrificed opportunities. For a company to produce a particular level of output and realize profits, it has to minimize the total cost of production (Nechyba, 2016). Small businesses maximize profit by choosing the optimal quantities of input to use and output to produce. The paper will entail an explanation of the rule for minimizing cost of production. Profit maximization and increased productivity are primary objectives of the small business, and it will attain such goals by minimizing costs of production.
Economic costs entail the sum of the company’s implicit and explicit costs. The owner of Pat’s Pizza Restaurant incurred various economic costs and the explanation to whether they are explicit or implicit costs is as follows. First, payment for rented manufacturing equipment is an explicit cost. It is because the transaction between the firm and the seller involved a direct monetary outlay. The firm spent money to get the equipment (Goodwin, Harris, Nelson, Roach & Torras, 2015). Second, a firm’s use of a warehouse that it owns and could rent to another firm is an implicit cost. The costs that the firm incurs do not involve spending cash. The firm foregoes the income it could get for renting the warehouse. Third, wages paid to the firm’s workers are explicit costs. The firm spends cash to pay its workers thus the costs incurred involves money exchange. Fourth, the wages the firm’s owner could earn if he/she worked for another country is an implicit cost. Although the owner of the firm could get the money, no actual money was spent on wages. The firm will incur an implicit cost because there was no monetary exchange.
Given the information on Pat’s Pizza Restaurant, the cost minimizing condition occurs when the slope of the isoquant equals the slope of the isocost line. That is MPL/MPK=w/r.
MPL/MPK = 100/4000 = 1/40
The price ratio is given by w/r = 10/500 = 1/50
The owner of Pat’s Pizza Restaurant is not minimizing costs because the ratio of the marginal product of labor and capital is not equal to the ratio of the price of labor to the price of capital. MPL/MPK is not equal to w/r.
The owner of Pat’s Pizza Restaurant should rent more oven and hire a fewer worker. An optimality condition is given as MPL/w=MPK/r. Whereby 100/10 = 10 pizzas per dollar and 4000/500 = 8 pizzas per dollar. The owner should increase the productivity of pizza by renting more oven and hire fewer workers so that the costs incurred equals.
If Pat wants to improve the productivity of the Restaurant, he might employ the following production decisions in both the short-run and long-run. Fixed costs are output sensitive and in the short-run, the input costs that might be fixed are the cost of technology and the physical plant. Examples of fixed inputs are the factory, offices, and equipment. In the long-run, the costs that might be variable are wages for labor and materials costs. Variable costs are output sensitive, and they will change when the output changes (Nechyba, 2016). Examples of variable inputs that the firm might use are the number of workers and the materials.
Some of the long-run economic decisions that Pat can make to increase productivity, minimize costs, maximize profit include the following. First, Pat can decide to increase the size of the plant. Increasing the size of the restaurant imply that the firm will be able to produce more output and maximize profit. Second, Part can decide to change the technology used by the firm. Technological change in areas such as transport, communication and logistics will increase the productivity of the business.
Goodwin, N., Harris, J. M., Nelson, J. A., Roach, B., & Torras, M. (2015). Principles of Economics in Context. Routledge.
Nechyba, T. (2016). Microeconomics: An intuitive approach. Place of publication not identified: Cengage Learning.
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