How Do You Find the Optimal Output Algebraically?

he production output of a plant can be expressed algebraically as a function of various input factors, such as labor and capital. The output equation defines the output for all input combinations, assuming that the most efficient methods of production are used. At the optimal output level, the marginal revenue, which is the additional revenue per unit of output, is equal to the marginal cost, which is the additional cost per unit of output.

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Get the production output equation. If your business has multiple plants, the production equation is likely to be different for each plant. For example purposes, assume that the production function is defined algebraically as Q = 10L^2 + 5L + 400, where "Q" and "L" represent production output and input labor costs, respectively.

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Find the marginal product of labor. Differentiate the production equation with respect to labor. In the example, using rules of differential calculus, the marginal product of labor is 20L + 5.
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Compute the marginal revenue at a given output price per unit. This is simply equal to the product of the marginal product of labor and the unit price. In the example, if the output price is $2 per unit, the marginal revenue product of labor is 40L + 10, or 2 times (20L + 5).

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Calculate the optimal output. Set the marginal revenue product of labor equal to the marginal cost of labor to find the optimal level of labor input. Then substitute the result into the production equation to calculate the optimal output. In the example, assuming the marginal cost of labor is constant at $50 per hour, set the marginal revenue product of labor equation to this cost. So 40L + 10 = 50, which means the optimal level of labor input equals 1: (50 - 10) / 40. To conclude the example, substitute this value into the production equation, Q = 10L^2 + 5L + 400, to get Q = 10(1)^2 + 5(1) + 400 = 415. Therefore, the optimal output is 415 units.

How to Determine Total Costs

firm's total expenditure or total cost consists of two components: fixed cost and variable cost. Fixed cost refers to all the expenditures that remain the same regardless of the quantity of outputs; for example rent on building and loan payments. Variable

cost, on the other hand, refers to the expenditures that change depending on the quantity of outputs produced. As you produce more outputs, you spend more. Examples are labor cost and the cost of raw materials.

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List and add up the fixed costs. This is the cost that remains the same whether you produce zero units or 1,000. Fixed-cost items include building rent and bank loan payments. Some costs might be fixed or variable. For example, building rent could be a variable expenditure if you can stop or start renting a warehouse at any time, depending on how much inventory you have.

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List the variable costs you incur and the rate at which you incur them. For example, you pay $20 for each labor hour. You could incur some variable costs per batch of several units. For example, you pay $500 for every extra 100 units you produce because you need to lease an extra machine.
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Write down the amount of variable cost items you have during the period in consideration. For example, for the previous month you use 500 labor hours and lease one extra machine.

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Multiply the rate of variable cost with the amount that you use. For example, you pay $10,000 for the 500 labor hours and $500 for the machine lease.

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Add up the variable cost items to get the total variable cost. In the example, you would incur $10,500 in variable costs.

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Add the fixed cost and the variable cost to get the total cost.

How to Calculate the Total Cost of a Product

In business, profitability occurs when revenue exceeds expenses. Using the total cost of a product to calculate expenses gives you a more accurate picture of profitability. The total cost of a product takes into account a wide range of expenses, including all fixed and variable costs associated with producing the product.

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Determine the accounting period for your calculations. To calculate your monthly total product cost, add the total fixed and variable costs for the month (that is, costs that represent a constant value and costs that fluctuate, respectively). If you want to determine annual product cost, add the total fixed and variable costs for the year.

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Compute the sum of all fixed costs associated with the product. Fixed costs exist even if a business does not produce any goods, and they remain constant regardless of the number of units produced. Overhead items represent the most common fixed costs and include all items associated with running the business. Example overhead costs include rent, utility payments and insurance premiums. Other potential fixed costs include equipment costs and depreciation. Identify these expenditures within the business accounting records and add the items to determine the total fixed costs.
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Compute the sum of all variable costs associated with the product. These costs can vary depending on how many units your business produces. Direct labor and material costs constitute the most common variable costs associated with an item. "Direct labor" refers to the wages paid to workers directly involved with the items production. Add the labor and material costs to determine the total variable costs.

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Calculate the total cost of all products by adding the total fixed and total variable costs. This sum represents the total cost of all units produced.

Tips & Warnings

"Average cost" refers to the per-unit cost of a product. Calculate average cost by dividing the total product cost by the number of units produced.

How to Calculate Total Cost in Economics

Total cost is an economic term that refers to the sum of all costs, including the fixed costs and variable costs. Calculating total cost is a necessary step in calculating average cost, which is the unit cost, or the cost of producing each individual product. For example, if the total cost of producing 100 calendars is $250, each calendar costs $2.50 to produce. Understanding costs is an important part of microeconomics, enabling you to compare costs with revenue and to calculate your profit.

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Calculate the fixed costs of the firm. Fixed costs are costs that remain the same regardless of quantity of production. For example, rent, interest on loans, property taxes and mortgage payments all represent fixed costs. Fixed costs are sometimes referred to as "sunk costs" because they must be paid, even if the firm produces nothing. Suppose the fixed costs of a firm are $5,000 per month.

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Calculate the variable costs of the firm. Variable costs are costs that change depending on how much the firm produces. For example, labor, raw materials and electricity are variable costs. Variable costs increase as production increases. Suppose the variable costs of the same firm are $20,000 per month.
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Sum the fixed costs and variable costs to find the total cost. In the example, the firm has a total cost of $25,000 per month.

Tips & Warnings

After calculating the total cost, divide it by the number of units produced to find the average cost per unit, or unit cost. If the firm in our example produces 5,000 units per month, the average cost is $5 per unit. Firms often want to sell more items because that decreases the fixed cost per item.

How to Calculate Average Cost in Economics

Average cost is an economic term that refers to the total costs of a business divided by the total number of products that are produced by that business. It is essential to know average cost in order to evaluate your business' profits, losses and overall budget.

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Add the total costs of your company within a certain period of time (such as a month or a year). This includes everything it takes to run your business, such as utilities, salaries, insurance and taxes.

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Figure the total quantity of products that your business produces in that same period of time.
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Divide your total from Step 1 by the quantity from Step 2 to find your average cost. For instance, if it takes $10,000 each month for your business to operate, and you produce 7,500 products each month, divide 10,000 by 7,500 to get an average cost of $1.33 per product.

Accounting Costs vs. Economic Costs

Is it worth it? Most financial decisions come down to this one simple question. Determining the answer, however, is not so simple. Whether an investment is seen as a profit or as a loss may depend on the types of costs analyzed. While revenue minus expenses equals profit, not all expenses qualify. Generally, profitability is determined by examining two types of costs: accounting costs and economic costs.

Accounting Costs

Accounting costs, also known as explicit costs, are costs that involve money being spent. Examples include rent, interest payments and utility bills. Another example would involve the decision to become a full-time student. Suppose someone quits her job and becomes a full-time student. If this person pays $30,000 for tuition and textbooks, but finds a $40,000-a-year job after graduation, her profit after attending college and working for one year is $10,000 (40,000 - 30,000 = 10,000). In this scenario, the $30,000 represents accounting costs, and the $10,000 can be thought of as accounting profit.

Economic Costs

Economic costs include accounting costs and implicit costs. Implicit costs, also known as opportunity costs, do not involve spending money; rather, they involve opportunities to earn money that are abandoned in a financial decision. Using the previous example with the college student, if the college student gave up a $20,000-a-year job to go to school for four years, the opportunity cost would be $80,000 (20,000 x 4 = 80,000). In this scenario, the college student would have a $70,000 economic loss one year after graduation, even with the $40,000 job (40,000 - 30,000 - 80,000 = - 70,000).

Sunk Costs

Sunk costs are costs that have already been incurred. In the scenario with the college student, the opportunity cost in the decision was the loss of a $20,000-a-year job. However, if the person was already planning on leaving that job, it would be a sunk cost. The $20,000 job would be lost whether the person went to college or not. Unlike accounting and economic costs, sunk costs should not be considered when making financial decisions.

Implications

Whether a project is deemed profitable can depend on which costs are analyzed. Accounting costs are most often used to determine profitability, but economic costs should not be ignored. If office or building space that could have been used for something else is used in a project, the opportunity cost should be taken into account. Ignoring economic costs or using sunk costs in a decision can artificially increase or decrease profit.