THE PRODUCTION FUNCTION AT TOYOTA

Throughout most of the 20th century, business in the United States, especially in manufacturing, was
dominated by the paradigms of mass production and scientific management. The focus was primarily on
finding ways to produce at lower unit costs without much overt concern about quality and consumer
satisfaction.

Now, a new view of the productive enterprise has emerged. The new view focuses more on quality and
customer satisfaction as the driving forces to long term business success. Terms such as TQM and
KAIZEN have become the buzzwords of the business community. Although the focus has shifted, the
result is the same. A business that focuses on continuous improvements is likely to find reduction in unit
costs along the way.

TOYOTA has found ways to reduce variations from the established quality standards, so that less rework
and scrap page result. As a result, the throughput of completed and saleable products per shift is
improved and the average unit cost is reduced.

TOYOTA has also found ways to increase the flexibility of production, between different types of
products. At TOYOTA, for example, the former goal of being able to make a die change in a minute has
been changed to a few seconds. As a result, completely different (much shorter) production runs that
enjoy the economies of mass production have become possible.

The short run average cost functions (based on newly evolved Production Functions) have been
regularly updated and used to ensure unit cost minimization.

(For the sake of this case, the actual figures are deliberately altered. All figures are in $ Thousands.)

The Variable Cost Function is represented by the equation:

VC = 18Q – 2.7Q2 +0.15Q3

Where Q is the quantity of Cars produced in a batch.

The Fixed Costs relevant to the model are $ 30,000 /-, Thus FC = 30 (since all units are in thousands)

Therefore, TC = FC + VC = 30 + 18Q -2.7Q2 +0.15Q3

Table 1: Unit Costs as a Function of the Output. (US $ 1000)

Q FC VC TC MC AFC AVC ATC

0 30 0.00 30.00 * * * *
1 30 15.45 45.45 15.45 30.00 15.45 45.45
2 30 26.40 56.40 10.95 15.00 13.20 28.20
3 30 33.75 63.75 7.35 10.00 11.25 21.25
4 30 38.40 68.40 4.65 7.50 9.60 17.10
5 30 41.25 71.25 2.85 6.00 8.25 14.25
6 30 43.20 73.20 1.95 5.00 7.20 12.20
7 30 45.15 75.15 1.95 4.29 6.45 10.74
8 30 48.00 78.00 2.85 3.75 6.00 9.75
9 30 52.65 82.65 4.65 3.33 5.85 9.18
10 30 60.00 90.00 7.35 3.00 6.00 9.00
1 30 70.95 100.95 10.95 2.73 6.45 9.18
12 30 86.40 116.40 15.45 2.50 7.20 9.70
13 30 107.25 137.25 20.85 2.31 8.25 10.56
14 30 134.40 164.40 27.15 2.14 9.60 11.75
15 30 168.75 198.75 34.35 2.00 11.25 13.25

As you will notice, the AVC = VC / Q = 18 – 2.7Q + 0.15Q2

To find the minima, equate the dVC/ dQ = 0

Thus, 0 = -2.7 + 0.3 Q or Q = 9.00 (The Unit Variable Cost is at its minimum at this level of
production quantity per batch.)

Also notice that, since, TC = 30 + 18Q -2.7Q2 + 0.15Q3 (and since the FC =30, is a constant anyway,
within our span of the decision) the MC depends only on the VC and not on the TC.

MC = dTC / dQ

= 18 – 5.4Q + 0.45Q2

And to find out the Minimum Marginal Cost, equate the derivative to Zero.

Thus, dMC /dQ = -5.4 + 0.9Q = 0, or Q = 6 (MC is at its minimum at Q=6, in a U shaped curve.)

Questions:
 1) Take a graph paper and plot the curves for the Average Fixed Cost, Average Variable Cost,
Average Total Cost and the Marginal Cost.
2) Explain why the minimum of the Average Total Cost Curve is at a higher output level that the
minimum of the Average Variable Cost Curve.
3) Explain why the Marginal Cost Curve cuts the Average Total Cost Curve as well as the Average
Variable Cost Curve at its minimum (or at the lowest point).
4) What do you understand by “Economies of Scale”? How did Toyota get it?
5) How many Cars would you produce in a Batch?
6) What will be your Total Cost per Car?
7) “The Cost is an achievement of the Company, whereas, the Price is a decision” Comment on this
statement.

MITSOB / NGA / MANEC / 2014