According to the different concepts of production, cost and profit maximization studied in class there are several concept that are tightly related to this article.
When we talk about costs, we cannot help but to think about the effect of an increase in cost in the long run period. As seen in chapter 8, the long run average cost curve will experience a shift to the right when there is an increase in cost due to an increase in the price of the inputs. In this case this concept is applicable, since the increase in cost is due to an increase in labor costs, and inflation in the unfinished goods (raw material that lead to the finished good).
According to what we saw in class, the goal of management is to maximize profit. As seen in chapter 2, the profit maximization level is reached when marginal revenue equals marginal cost. This would determine the optimal level of output at which profit is maximized. Assuming that the company is already employing profit maximization strategies, such as determining P*, and Q* to get Profit*; the company might need to revue its Q*. If Marginal Costs increase due to an increase in the inputs pricing, then the company will face a decrease in Q*, P* will have to increase and profitability*, will decrease. The problem with the marginal cost of the companies, during this time of the year is that they are facing a higher increase in the costs in proportion to the increase in the prices that they could charge to their customers. The consequence of this is that the companies will be facing a higher decrease in their profits. If the profits* are less than zero, the companies will have to face the question seen in class: Shut down? Which translates to a temporal suspension of operations.
Another situation they should consider is the alternatives they have to reduce costs different from the decrease in input prices. A way to decrease their costs is to increase the learning curve. The learning curve is the average cost reduction over time due to production experience. This will significantly reduce cost, because the workers are more experience that allows the firm to produce output more efficiently at each and every output level. Productive efficiency leads to a downward shift in the long run average cost curve at all levels of output. Another choice they have to decrease their costs is by determining the optimal level of the inputs used in the production of their products. If the company allocates based in the input that has higher MP/P ratio, this will lead to maximizing the amount of output that the company gets with the same amount of expenses.
BIBLIOGRAPHY
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Fundamentals of Managerial Economics, Hirschey Mark, 7th Edition, Thomson SouthWestern.
- US: The Coming Battle between Profits and Prices, BusinessWeek Online, December 06,2004