A firm that uses labour and capital to produce a single output would mean that the firm in question can vary amounts of all their inputs to minimise the cost of production for the firm. The cost of production is when a firm produces several goods simultaneously, the cost of each may depend on the quantity of all the goods produced (App.kortext.com, 2017). Due to all input quantities of the firm being variable, this means the firm is running in the long-run. The graph also clearly displays the relationship between labour and capital to be perfect complements to each other. The firm behaviour of the input and output quantities could change depending on what type of market the firm is in; competitive or non-competitive market.
Due to the varying amounts of all the inputs of the firm would minimise the cost of production for the firm. The cost function for a firm means the function relating the cost of production to the level of output and other variables that the firm do have control over. The cost of production shows when a firm produces several goods simultaneously, the cost of each may depend on the quantity of all the goods produced (App.kortext.com, 2017).
To find the cost production use the following equation:
C(q) = wL+rK
The function depends on the two constants L and K, it would be preferable to express these two constants in factor prices and parameter. We could express this by observing that the firm chooses the cost-minimising combination of labour and capital. However, the cost function can only use as it is solely dependent on the factors which are variable. As some factors are variable this would mean it is in long run production which is described by Pearsons Microeconomics as the time period in which all inputs may be varied but in which the basic technology of production cannot be changed (Pindyck and Rubinfeld, 2008). The cost of production is lowered due to all the inputs being variable, therefore this means the firm has additional funds/retained earnings that they could spend on the expanding. The firm could expand by enlarging the firm’s operations or hiring more labour for a higher level of output if there is an increasing demand for consumers. A firm’s expansion path shows how the cost-minimising input choices vary as the scale or output of its operations increases (Pindyck and Rubinfeld, 2008). As a result, the expansion path provides useful information relevant for long-run planning decisions (Pindyck and Rubinfeld, 2008). The expansion path describes the combination of labour (L) and capital (K) that the firm must choose to lower costs at every level of output. As long as the use of both labour and capital increases with the output, the curve would be upward sloping (Pindyck and Rubinfeld, 2008). This is clearly shown in the graph for the firm in question, it has a positive curvature for the quantity/ the level of output for the amount of labour and capital inputted.
As all the input quantities for the firm are variable, this therefore means that the firm is producing in the long run. When a firm produces in the long-run is defined by Pearsons Microeconomics as a ‘time period in which all inputs may be varied but in which the basic technology of production cannot be changed’ (Pindyck and Rubinfeld, 2008). In turn, the decisions made in long-term planning determine the short-run costs due to the fact that firms cannot vary in the short-run but can in the long run; the short-run cost is at least as high as long-run cost and higher if the ‘wrong level of capital is used in the short-run (App.kortext.com, 2017). The long run shows the positions of the firm when planning to go into business, such as expanding of its operations or headquarters or labour power. This means the firm has much more flexibility due to the fact it can expand its capacity by expanding current holdings of factories or building new ones. The firm can expand or contract its labour force, and in some cases, it can change the decision of its products or introduce new production (Pindyck and Rubinfeld, 2008). However, compared to the short run which does not correspond to a specific length of time, the short run is a period of time in which quantities of one or more production factors that cannot be changed, thus making the short run inflexible. For the firm to flexible it would make it more competitive as it can change with the market and the demand from consumers. In the long-run, the firm can adjust the amount of capital (K) it uses, if the capital includes specialised equipment that has no other use in the firm other than that of which it is doing. The rental rate for the specialised machinery is also important as without the company has no production, these rates could fluctuate and the company would have no option but to pay the rates, thus the rate and quantity of production can be affected. These rates can be forced on a firm especially in times of economic downturn or when the interest rates of the country fluctuate. The firm can choose to lower costs in the long-run, for instance when a firm is choosing the size of their plants and making investment decisions they have to take into account how to minimise its long-run cost based on how many units of output there is (App.kortext.com, 2017). The long-run costs are lower than the short-run due to firms being flexible and technological progress may lower over time. The productive skills and knowledge of better ways to produce thus gaining them experience and becoming specialised workers this in turn benefits the firm, the workers increase in speed with practise (App.kortext.com, 2017). Once the workers have a faster speed at working and thus producing a product, the quantity produced would be higher with a lower input of labour. The workers become increasingly adept the more often they perform a task (App.kortext.com, 2017). The diagram would then change to a much steeper incline of the demand curve, but only if the production of the output required less labour at the same level of input the capital required for production. If the process of production is more effective by using various production methods to find the right one to suit the firm. This is one of many reasons that would contribute to the average cost of production to fall over a period of time, this would often have a greater effect on new products. New products for the firm would also diversify the firm and could introduce new production methods that could be improved with the new product. New products also bring in an added profit margin at the beginning of its life cycle such as a firm can afford to set higher when it first enters the market to gain a higher profit from early adopters.
The production function shows the amount of labour and capital input into the firm directly corresponds to each other, the amount of capital needs the same amount of labour to produce the quantity of output. The production function can be shown formally as: F(K,L)
The minimum production for this company is F(K,L)=min (2K,2L). This represents the inputs needed to produce a given level of output; for the firm in question it is no lower than 2 unit of output. If in the short run, which this firm is not in, the firm’s capital would be fixed, the firm could only increase its output if labour was increased in order to compensate. The production function governs how the shape of the cost curve will be; the shape of the cost curve of which a firm relies on when making decisions about labour and capital. The graph clearly shows that the firm relies on the labour and capital being the exact same amount to produce a given level of output. For this firm, they are not able to have low levels of labour and will have to have a constant input of capital in order to carry on producing at a satisfactory level for shareholders as well as investors. Investors would want to see the firm producing at the highest level of output in the most efficient way, without over using labour or capital that would affect profits for long term investments. If there is too much labour and capital being inputted it could cause overproduction and if there is not a high level for demand, the output would then be discarded or be kept in holding inventory. When inventory is held and there is overproduction this would bring production to a halt as there is too high a level of output and the company would be making a loss if it continued producing. The production process is so important for every business including this firm as this is what produces to generate money to carry on surviving and thriving. Once a firm becomes more efficient when producing sometimes the firms that produce to order, survive the best as they are only producing what is needed/demanded from consumers. For a firm to produce efficiently without increasing costs it must first determine which of its production processes are technologically efficient so it can produce the required level of output for the fir with the least amount of inputs. The second step for the firm is to select the most technologically efficient production process that is also economically efficient, this would therefore reduce the cost of production (App.kortext.com, 2017). This firm could also not be able use cost minimisation due to the fact that the output is not varying for them, the amount of labour and capital that is put into the production process would equal to the amount of output produced.
Costs are a vital part of any firm and every decision made is so costs to remain low especially in the long run. By reducing its cost of producing a given level of output, a firm can increase its profit. Any profit-maximizing competitive, monopolistic, or oligopolistic firm minimizes its cost of production (App.kortext.com, 2017). A firm can measure its costs, economists measure costs by including all relevant costs, they see that the prices in a firm reflect the alternative possible uses of factors, generally market prices and this is the principle of opportunity costs. The prices and costs for a company are measured in flow terms which means these are in units per unit of time. This is shown for the firm with the units of labour and capital that they use. The prices for firms are always shown as they would for market value so this means the price is only taken into account what the input would have been if it had been purchased or rented for use. The cost of the capital must also be considered also known as the user cost of capital; this is the annual (yearly) cost of owning and using a capital asset, equal to economic depreciation plus foregone interest (Pindyck and Rubinfeld, 2008). This is shown as:
User Cost of Capital = Economic Depreciation + (Interest Rate) (Value of Capital)
This should also be deliberated when looking at the firm due to it being a cost for the company and affecting the profits as well as retained earnings for future endeavours. The firm can choose can choose its inputs combinations can be used minimise the cost of producing a certain output. The input combinations can be changed when information about wages and the user cost of capital is considered. In order for a firm to run profitably the shareholders must look at all relevant costs and direct the firm’s accountant to measure costs in ways that are more consistent with laws; in order for the firm to look good to stockholders (App.kortext.com, 2017). The value of the capital changes over time, such as it depreciates in value or time, due to new versions being used or the use of the machine such as wear and tear (App.kortext.com, 2017). ‘To minimize the cost of producing a given level of output, a firm should choose that point on the q0 isoquant at which the rate of technical substitution of l for k is equal to the ratio w/v: It should equate the rate at which k can be traded for l in production to the rate at which they can be traded in the marketplace’ (Albany.edu, 2017).
Overall, the graph shows that the amount of input that is put into the business is what will be produced, the level of output that is produced correlates directly to the units of K and L inputted. The firm is running in the long run due to all the inputs are variable in the cost function, the prices, this means that the firm can be more flexible due to the fact it can expand its factories and holdings. The firm could choose to lower costs as it can expand and contract as it wishes, so for instance the firm could down size its labour and capital that it inputs as a response to demand for the product. This would make the firm very competitive as it is able to respond to the need of consumers and demand. This would especially be helpful in times of economic downturn or upturn so the firm could respond to this and make sure they are not making a loss by either over or under-producing. This shows that the firm is also cost-minimising as it is flexible to change so it doesn’t make a loss.