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Economics and the 2008 crisis: a Keynesian view
Economics and the 2008 crisis: a Keynesian view

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7.3 Production cost

Efficiency and production costs are two issues firms pay careful attention to. If a firm is to compete and survive, it must be an efficient organiser of different inputs into production. Firms must use production inputs like raw materials, labour and capital efficiently as these will reduce production cost.

Cost minimisation is an important objective for a firm, as you have seen in the video, Facing the competition in Section 7.1. Reducing cost helps to increase profit, the difference between the sales value of output (revenue) and production cost. Higher costs are often cited as responsible for influencing profits in the retail sector, for example the popular retailer H&M posted a smaller than expected rise in profit in 2012 because of rising input cost.

H&M profits hit by higher costs

Figure 28 Hennes & Mauritz is the world's third biggest clothing retailer

Profits at the world's third biggest clothes retailer, Hennes & Mauritz, have edged higher.

In the first quarter H&M made a net profit of 2.7bn Swedish krona ($406m; £255m), up from 2.6bn krona in the same period in the previous year.

The company said that profits were hit by higher purchasing costs, which it did not pass on to customers.

H&M also announced that it will launch a new independent chain of stores next year.

H&M chief executive Karl-Johan Persson said: "The new year has started well with a strong sales increase in the first quarter.

"Despite increased purchasing costs we have continued to strengthen our customer offering."

The company plans to open its first stores in Bulgaria, Latvia, Malaysia, Mexico and Thailand this year.

BBC (2012)

Critically, if firms fail to manage costs, they risk going out of business because the cost of production exceeds the revenue received.

Production cost can be reduced by increasing productivity (reducing the quantity of inputs needed to produce the same output) or using inputs with a lower price. One way to reduce input price is to make use of cheap labour in production through offshoring parts of the production process.