Production Costs and Profits Business Is Booming Essay

Excerpt from Essay :

Production, Costs, And Profits

Business is booming at a local fast food restaurant. It is contemplating adding a new grill and French fry machine, but the day supervisor suggests simply adding more workers. How should the manager decide which alternative to pursue? What would happen if too much labor is hired without an addition to capital? Explain using economic terms.

It is difficult to answer this question without understanding the current capacity of the restaurant. In order to truly answer this question, one would have to understand if there are already workers dedicated to running the grill and French fry machines in a way that they already operating at or near full capacity. If the answer to that question is no, then increasing production may be a simple matter of increasing the number of employees, so that an employee could be dedicated to running the food preparation equipment, thus maximizing potential output. The restaurant may very well be able to use existing equipment to meet current demand and the demand for the foreseeable future simply by adding employees. In fact, in a fast food restaurant setting, it is important to understand that growth is not unlimited; there are only so many potential customers for a fast food restaurant in a given area, and, particularly given the high rate of competition among fast food restaurants and their necessarily limited menus, it is unlikely that a single restaurant will be able to completely monopolize that available business. Does the restaurant have a long-term potential to be able to utilize the new machinery at full capacity or would full capacity on the existing machinery be able to meet the restaurants needs? If the existing machinery can meet the needs, then hiring more labor is a good solution.

However, if the answer to that question is yes, then adding more workers will do nothing to increase the food production capabilities of the restaurants. In that case, the manager should add a new grill and French fry machine, as well as hiring more workers. All of the employees are constrained by the capital available to make the products. In other words, the total output of the fast food restaurant cannot exceed the total output of the grill and the French fry machine, regardless of how many workers are employed at the restaurant. Once the French fry machine is operating at maximum capacity, there is no way to make additional French fries without getting a new French fry machine. This reflects the law of diminishing marginal returns, so that, at this point, the addition of each new worker would result in a smaller incremental increase in production, and might actually not be profitable to the business, because of the other costs of production (Rittenberg & Tregarthen, 2009).

2. How does this article apply the marginal decision rule to the problem of choosing the mix of factors or production (capital intensive vs. labor intensive methods of production)? How do maquiladoras benefit the U.S. economy?

The marginal decision rule assumes that a firm's only goal is maximizing profit. The marginal decision rule is: "Expand production if and only if the price is greater than the marginal cost… Increasing production makes both total cost and total revenue go up. If the revenue goes up more than the cost, profit goes up. (Profit = total revenue - total cost.) Marginal cost is how much cost goes up from making one more. The price is how much revenue goes up from selling one more…If the price is bigger than the marginal cost, then what you gain in revenue is greater than what you lose in added cost. That makes your profit higher, so you should go ahead and expand production. On the other hand, if price is less than marginal cost, increasing production costs you more than the revenue you gain. You should not expand production" (Baker, 2000).

The article applies the marginal decision rule to the problem of choosing the mix of factors of production (capital intensive vs. labor intensive methods of production) by looking at the relative costs of exporting items for labor-intensive production in Mexico rather than either doing capital improvements at those locations or in other locations. What companies found was that labor-intensive production could only take them so far, and those companies have done capital improvements at their Mexican manufacturing locations. Mexico's maquiladora companies today boast state-of-the-art production technology. Research and design centers are now part of the maquiladora landscape as well" (Vargas, 2001).

Maquiladoras benefit the U.S. economy in a number of ways. First, they can really benefit border cities. "El Paso has carved an important niche in serving the maquiladora industry, especially in plastic injection molding. This demonstrates that border cities such as El Paso -- which have traditionally lacked a sophisticated industrial base -- can nonetheless attract investments using their formidable advantage with the lucrative maquiladora market. The total maquiladora inputs or components market in Ciudad Juarez alone was worth nearly $13 billion in 2000. The industry's components market along the Texas border -- from Juarez to Matamoros -- was a massive $23 billion in 2000, roughly 42% of the maquiladora industry's total components market ($55.3 billion)" (Vargas, 2001). In addition, "Maquiladoras import 97% of the components they use. And 80 to 85% of these come from the United States, mostly from states not bordering Mexico" (Vargas, 2001).

3. Why have generic drug companies been so successful? What economic and/or political conditions would cause a generic drug maker to go out of business?

Generic drug companies have been so successful because they are able to offer drugs that are practically identical to brand name prescription drugs without taking on the burden of developing those drugs. A huge part of the costs of a prescription drug are related to the research and development of creating that drug. Generic competitors do not have to shoulder the burden of those R&D costs; in fact, many generic manufacturers do not engage in any new drug development. "The generic drug industry is largely characterized by the attributes of a perfectly competitive market. Competitors have good information about the product and sell identical products. The largest generic drug manufacturer in the CBO study had a 16% share of the generic drug manufacturing industry, but most generic manufacturers' sales constituted only 1% to 5% of the market. The 1984 legislation eased entry into this market. And, as the model of perfect competition predicts, entry has driven prices down, benefiting consumers to the tune of tens of billions of dollars each year" (Rittenberg & Tregarthen, 2009).

The political condition that could easily drive generic drug makers out of business would be a repeal of the Drug Competition and Patent Restoration Act of 1984, or any similar law that would increase the amount of time that name-brand drugs were patent-protected. Any factor that impacted the idea of perfect competition might drive drug makers out of business. For example, if health insurance companies refused to provide coverage for generic drugs, but would only cover the name-brand drug, it might impact competition. In fact, the textbook's description of perfect competition for this market is somewhat misleading, because many people do have prescription drug coverage, but the co-pay for a name-brand drug may be much greater than the actual cost differential between the generic and the name-brand, which increases an artificially favorable system for the generic drugs. Simply changing that system might impact the use of name brand drugs.

4. What is the difference between the short-run and the long-run for a perfectly competitive firm in terms of costs and profits? Explain why a perfectly competitive firm may continue to operate in the short-run even with a loss of profits.

In a perfectly competitive market, a firm has no control over its pricing, only over…

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