A really simple economics question

[Exsubmariner]

What is it about the laws of the market that makes producing things on a larger scale cheaper per item produced?

Everyone seems to take that for granted, but I have been thinking on it. Take cutting down trees as an example. If I am a logger, I can swing my axe (it's before chainsaws) so many times a day and chop so much wood. My labor would have a linear relationship to how many trees got cut. Now if there were many more loggers out in the forest cutting down trees, competition would drive down prices, but what is produced compared to the cost of labor should remain consistent.

If a chainsaw came along, now labor is more efficient and more trees can be cut per time spent. That should lower prices through increased efficiency. But, simply producing more trees by putting more loggers in the forest doesn't lower production costs in terms of energy expended.

Therefore, the question I think comes down to market and supply and demand. I don't think that producing more of any given thing will necessarily lower the cost of doing so, assuming the absence of something that allows for greater efficiency. I think this holds true with just about anything from resources to widgets.

In summary, I think that there is a balance that has to be struck between what the market will buy and what is produced in order to make producing profitable. If you produce too much, you could put yourself out of business. Am I correct?

[Borodog]

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What is it about the laws of the market that makes producing things on a larger scale cheaper per item produced?

Everyone seems to take that for granted, but I have been thinking on it. Take cutting down trees as an example. If I am a logger, I can swing my axe (it's before chainsaws) so many times a day and chop so much wood. My labor would have a linear relationship to how many trees got cut. Now if there were many more loggers out in the forest cutting down trees, competition would drive down prices, but what is produced compared to the cost of labor should remain consistent.

If a chainsaw came along, now labor is more efficient and more trees can be cut per time spent. That should lower prices through increased efficiency. But, simply producing more trees by putting more loggers in the forest doesn't lower production costs in terms of energy expended.

Therefore, the question I think comes down to market and supply and demand. I don't think that producing more of any given thing will necessarily lower the cost of doing so, assuming the absence of something that allows for greater efficiency. I think this holds true with just about anything from resources to widgets.

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Overhead, for one. Very often when you produce more, your overhead doesn't change linearly. As an example, take the overhead in gasoline from driving back and forth to work. You have the same overhead if you work 15 minutes or 15 hours. So your per unit costs (maybe your per hour costs in that situation) go down the more (hours of work) you produce.

Second is volume. Very often businessmen are willing to trade higher profits for the certainty of selling a higher volume.

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In summary, I think that there is a balance that has to be struck between what the market will buy and what is produced in order to make producing profitable. If you produce too much, you could put yourself out of business. Am I correct?

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Yes, but I'm unclear on how this is related to your OP. If you produce more than what you can sell, your surplusses with either sit unsold or you may have to lower prices until your shelves will clear, either of which means you can suffer losses.

[Cue-Ball 66]

If you produce too much of anything, yes, you'll put yourself out of business. Make a million coffee mugs when you're only going to sell a thousand is obviously going to cost you more than you make on revenue (unless you sell your mugs for a thousand times what it costs to make them).

[Exsubmariner]

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Overhead, for one. Very often when you produce more, your overhead doesn't change linearly. As an example, take the overhead in gasoline from driving back and forth to work. You have the same overhead if you work 15 minutes or 15 hours. So your per unit costs (maybe your per hour costs in that situation) go down the more (hours of work) you produce.

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This is interesting. In my logging example, I have to eat. If I spend one more hour a day chopping wood, I still eat the same amount, my overhead stays the same, but my production goes up due to time spent.

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Second is volume. Very often businessmen are willing to trade higher profits for the certainty of selling a higher volume.

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You mean in terms of percentage per unit profit? Lower % profit but more sold equals more $$?

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Yes, but I'm unclear on how this is related to your OP. If you produce more than what you can sell, your surplusses with either sit unsold or you may have to lower prices until your shelves will clear, either of which means you can suffer losses.

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I'm kind of quantum leaping here. I was thinking specifically about technology driven products. If you produce too many and something better comes out, than you are virtually gauranteed a loss. I believe several computer companies have failed in this manner.

[Cue-Ball 66]

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You mean in terms of percentage per unit profit?

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No. Overall profit. As in Revenue minus Costs. It doesn't matter how many you sell, it matters what your overall profit is. Optimization etc.

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Lower % profit but more sold equals more $$?

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Yes.

[Man of Means]

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This is interesting. In my logging example, I have to eat. If I spend one more hour a day chopping wood, I still eat the same amount, my overhead stays the same, but my production goes up due to time spent.


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Suppose you consume and burn 2000 calories doing no work. That is your fixed cost. If you work, you need an additional 550 calories per hour of work. That is your marginal cost.

So we have a linear function
C = 2000 + 550*H
where H is hours of work (or output).

If you work 1 hour, your calorie need is 2550, and your average cost is 2550 calories per hour of work.

If you work 5 hours, your calorie need is 2000 + 550(5) = 4750, and your average cost is 950 calories per hour of work.

So you have lowered your average cost per unit of output even though your marginal cost is a constant. What happens is the fixed costs (overhead) get averaged out over more units of output.

[Borodog]

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Overhead, for one. Very often when you produce more, your overhead doesn't change linearly. As an example, take the overhead in gasoline from driving back and forth to work. You have the same overhead if you work 15 minutes or 15 hours. So your per unit costs (maybe your per hour costs in that situation) go down the more (hours of work) you produce.

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This is interesting. In my logging example, I have to eat. If I spend one more hour a day chopping wood, I still eat the same amount, my overhead stays the same, but my production goes up due to time spent.

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Yes, of course. There are always costs that go linearly with production, but again, there are many that don't. So making more lowers your per-unit costs.

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Second is volume. Very often businessmen are willing to trade higher profits for the certainty of selling a higher volume.

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You mean in terms of percentage per unit profit? Lower % profit but more sold equals more $$?

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Yes. This effect is general. This is why daily rental rates, for example, are more than weekly rental rates, which are more than monthly rental rates. The landlord is willing to make less profit in exchange for the certainty that his unit will remain filled longer.

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Yes, but I'm unclear on how this is related to your OP. If you produce more than what you can sell, your surplusses with either sit unsold or you may have to lower prices until your shelves will clear, either of which means you can suffer losses.

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I'm kind of quantum leaping here. I was thinking specifically about technology driven products. If you produce too many and something better comes out, than you are virtually gauranteed a loss. I believe several computer companies have failed in this manner.

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Yep. I think that just-in-time production helps minimize this. Keep as few units on the shelves as possible.

[JMAnon]

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Take cutting down trees as an example. If I am a logger, I can swing my axe (it's before chainsaws) so many times a day and chop so much wood. My labor would have a linear relationship to how many trees got cut. Now if there were many more loggers out in the forest cutting down trees, competition would drive down prices, but what is produced compared to the cost of labor should remain consistent.

If a chainsaw came along, now labor is more efficient and more trees can be cut per time spent. That should lower prices through increased efficiency. But, simply producing more trees by putting more loggers in the forest doesn't lower production costs in terms of energy expended.



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Five loggers can carpool to the forrest, all sleep in the same cabin, share the well water, etc. If each logger has to drive his own car, build his own cabin, and dig his own well, his costs will be much greater (on a per logger basis) than five loggers who share the costs.

[MrMon]

I think you are mixing two different concepts. One is the capital/labor tradeoff, which just complicates the original problem, so we'll ignore it. Let's go back to the loggers and restate the problem.

One logger with Y set of tools can cut down a tree in X amount of time. If we have five identical loggers, each with the exact same set of tools, can they produce more than 5 trees in X amount of time? Yes, because the larger number of men allows for specialization of labor.

If you break down the task of cutting down the tree, there are many individual tasks, such as maintaining the axes, cutting down the tree, striping the branches, splitting the logs, hauling the wood, etc. Rather than having just one man do all the tasks, having them specialize or assist each other in certain tasks will lead to greater efficiency. At some point, the number of men on the task becomes close to optimal, so adding more men doesn't make it more efficient, but in any sufficiently complicated task, many are almost always more efficient than one.

[hmkpoker]

If you produce more than the market wants, you lose money.

If you produce more of what the market wants, you make money.

[Go Blue]

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What is it about the laws of the market that makes producing things on a larger scale cheaper per item produced?

Everyone seems to take that for granted, but I have been thinking on it. Take cutting down trees as an example. If I am a logger, I can swing my axe (it's before chainsaws) so many times a day and chop so much wood. My labor would have a linear relationship to how many trees got cut. Now if there were many more loggers out in the forest cutting down trees, competition would drive down prices, but what is produced compared to the cost of labor should remain consistent.

If a chainsaw came along, now labor is more efficient and more trees can be cut per time spent. That should lower prices through increased efficiency. But, simply producing more trees by putting more loggers in the forest doesn't lower production costs in terms of energy expended.

Therefore, the question I think comes down to market and supply and demand. I don't think that producing more of any given thing will necessarily lower the cost of doing so, assuming the absence of something that allows for greater efficiency. I think this holds true with just about anything from resources to widgets.

In summary, I think that there is a balance that has to be struck between what the market will buy and what is produced in order to make producing profitable. If you produce too much, you could put yourself out of business. Am I correct?

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To answer your first question, as someone mentioned, it's mostly all about overhead. If you open up a car factory with the capacity to *efficiently* make a certain amount of cars per year, say 1000, then you'd be losing money by only making 500 cars per year. Sure, to increase the production to 1000, you would need more workers, which costs more money, but you have to factor in your fixed costs (mainly the factory itself), and in addition, things like electricity, office supplies, management costs, etc. Some of them stay the same whether you produce 500 or 1000 cars and some of them don't increase enough to offset the extra profit made from producing one extra car. Therefore, the AVERAGE cost per car will decrease, even though the total cost will increase. If you try and produce more than the factory can efficiently handle, say, 1200, your costs per unit car will now begin to rise, due to overcrowding, organization problems, wasted time, etc.

As for your second question, this is true only after a certain extent. Producing more of something will lower the cost, but it will also increase demand. At first, the increase in demand will more than offset the price decrease, thus raising overall profits. Eventually, the opposite will occur, thus decrease per unit profits. If, right now, ExxonMobil found more oil somewhere and the price of oil dropped somewhat, they would still make more money as there is such tremendous demand for it.

[Cue-Ball 66]

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Producing more of something will lower the cost, but it will also increase demand.

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Are you sure? I could make ten paper aeroplanes because I know ten kids that want paper aeroplanes. But simply making a thousand paper aeroplanes isn't going to make more kids that want them.

More items are produced if demand increases, I didn't think it worked the other way.

[MrMon]

I think what he meant was that when you lower the cost, demand will increase. Just producing more will not increase demand, lowering the price will.

[Cue-Ball 66]

Ahhh, umderstood.

[JMAnon]

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I think you are mixing two different concepts. One is the capital/labor tradeoff, which just complicates the original problem, so we'll ignore it.

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How so? I view the gas, cabin and well as overhead -- overhead that doesn't increase as you increase the amount of production by adding loggers. I think that sufficiently addresses OP's point.

[MrMon]

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I think you are mixing two different concepts. One is the capital/labor tradeoff, which just complicates the original problem, so we'll ignore it.

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How so? I view the gas, cabin and well as overhead -- overhead that doesn't increase as you increase the amount of production by adding loggers. I think that sufficiently addresses OP's point.

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Sorry, I was trying to reply to the OP and quick reply addressed it to you. He was complicating the problem by bring in chainsaws. This is the classic Adam Smith pin production problem, so you need to fix the technology in use.

[Exsubmariner]

AH HA!

I thought there was something wrong with the reply placement.

The idea of loggers dividing up tasks really wasn't in my thought processes. I am familiar with the pin problem. Some of what I was thinking about was actually in terms of flooding the market with one particular product. I think it is theoretically possible to lower prices to the point that production is unprofitable.

[Exsubmariner]

I really like this breakdown about the calorie cost. I think the effect is only present because there is a certain baseline cost. Perhaps in economics, this could be equated to cost of living in $?

[MathEconomist]

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AH HA!

I thought there was something wrong with the reply placement.

The idea of loggers dividing up tasks really wasn't in my thought processes. I am familiar with the pin problem. Some of what I was thinking about was actually in terms of flooding the market with one particular product. I think it is theoretically possible to lower prices to the point that production is unprofitable.

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I'm not sure what you mean by this, so I'm not entirely sure how to correct your thinking. Basically, markets can have different structures. A perfectly competitive market behaves differently from an imperfectly competitive one, which behaves differently from a monopoly market.

I guess the best way to address this is to go over the basics of what happens in these cases, and hopefully the answer is contained there.

In a perfectly competitive market (these don't actually exist, but in some cases it is a very good approximation to the real world), you have NO control over prices at all(if you do have some control, you are not in this kind of market). You are presented with a market price. You can sell as much product as you like at this market price, so you have no incentive to charge a lower price. If you tried to charge a higher price, you get zero business. So prices are fixed. You then produce as long as it is profitable on the margin (if you had really funky costs you'd need to check second order conditions too, but we'll ignore that for now). In order to make this work, we usually assume that marginal costs are increasing beyond a certain point (in the logging example, this might mean that it takes you longer to cut down a tree at the end of a work day than the beginning) because otherwise you will want likely want to produce an infinite amount of product, and we don't see that in the real world. So basically, you are confronted with a price, and you decide how much you want to produce given that price, and then you do the production and sell the product and realize profits or losses. In a long run equilibrium, you should find yourself making just enough to cover your costs (including opportunity costs).

Now, in the real world, most markets are imperfectly competitive, and some are oligopolies and monopolies. Let's just ignore the oligopoly case since it is complicated. In a monopoly or imperfect competition setting, you basically make production decisions in about the same way. Instead of being confronted with a market price, you are confronted with a demand curve. This demand curve relates how your product will sell with respect to price. At each price, you know the amount people will buy (in the real world, you face uncertainty about this curve and have to estimate it, but for our purposes we assume it is known.) Further, you also have the same knowledge about costs as before. Now your production decision consists of simultaneously choosing a price and quantity to maximize profits. You do this similarly to in the earlier case, except now you are interested in marginal revenue instead of price. Marginal revenue takes into account that in order to sell a larger quantity, you have to lower price. As before, the optimal decision sets MR=MC (again subject to the same caveats as before about SOC).

So I hope this answers your question. This is how the markets work (well, more or less. More accurately this is an abstraction of how they work). If this doesn't make sense you are likely better off PMing me than responding as I don't read this forum often anymore. I feel though like this ought to clear up some of your confusion about prices and profit.

[hmkpoker]

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Producing more of something will lower the cost, but it will also increase demand.

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Are you sure? I could make ten paper aeroplanes because I know ten kids that want paper aeroplanes. But simply making a thousand paper aeroplanes isn't going to make more kids that want them.

More items are produced if demand increases, I didn't think it worked the other way.

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With more paper airplanes, you can charge less.

Producing more bottles of glenlivet isn't going to make me like it more. Lowering the price as a result of increased production, however, will turn me into a very happy drunk /images/graemlins/smile.gif

[GMontag]

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Producing more of something will lower the cost, but it will also increase demand.

[/ QUOTE ]

Are you sure? I could make ten paper aeroplanes because I know ten kids that want paper aeroplanes. But simply making a thousand paper aeroplanes isn't going to make more kids that want them.

More items are produced if demand increases, I didn't think it worked the other way.

[/ QUOTE ]

With more paper airplanes, you can charge less.

Producing more bottles of glenlivet isn't going to make me like it more. Lowering the price as a result of increased production, however, will turn me into a very happy drunk /images/graemlins/smile.gif

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The demand curve for non-luxury items is flat within a reasonable range of prices. And the more essential the product is, the larger the price range where it is flat. People aren't going to change their driving habits (i.e. their consumption of gasoline) unless there is a fairly drastic change in prices. For an extreme example, a life saving medicine is going be demanded by every person with the illness it cures no matter how much it costs. It will never be demanded by anyone else no matter how little it costs.

[soon2bepro]

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What is it about the laws of the market that makes producing things on a larger scale cheaper per item produced?

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The fact that you can concentrate on making your product cheaper per item produced, instead of worrying of the total invested amount of money.