Basic Cost Accounting Will Tell Why Salaries Can't Be Increased While Reducing Cost Of Goods/Services At The Same Time

It's a very common demand by Filipino communists to increase salaries while wanting the cost of goods to be lowered at the same time. Such a statement is made out of ignorance. I remembered having my cost accounting classes in college. I decided to dig through cost accounting again to discuss this common sense post. 

Understanding the basics of production costs

This time, I decided to read through Investopedia to find out about production costs. Here's an introduction to how production costs work. Certain points are highlighted in pink (pun intended) to help show how salaries help contribute to an increase in prices in finished goods and services. 

What Are Production Costs?

Production costs refer to all of the direct and indirect costs businesses face from manufacturing a product or providing a service. Production costs can include a variety of expenses, such as labor, raw materials, consumable manufacturing supplies, and general overhead.

KEY TAKEAWAYS

• Production costs refer to the costs a company incurs from manufacturing a product or providing a service that generates revenue for the company.
• Production costs can include a variety of expenses, such as labor, raw materials, consumable manufacturing supplies, and general overhead. 
• Total product costs can be determined by adding together the total direct materials and labor costs as well as the total manufacturing overhead costs. 

Understanding Production Costs

Production costs, which are also known as product costs, are incurred by a business when it manufactures a product or provides a service. These costs include a variety of expenses. For example, manufacturers have production costs related to the raw materials and labor needed to create the product. Service industries incur production costs related to the labor required to implement the service and any costs of materials involved in delivering the service.

Taxes levied by the government or royalties owed by natural resource-extraction companies are also treated as production costs.1 Once a product is finished, the company records the product's value as an asset in its financial statements until the product is sold. Recording a finished product as an asset serves to fulfill the company's reporting requirements and inform shareholders.

Total product costs can be determined by adding together the total direct materials and labor costs as well as the total manufacturing overhead costs. Data like the cost of production per unit can help a business set an appropriate sales price for the finished item.

To arrive at the cost of production per unit, production costs are divided by the number of units manufactured in the period covered by those costs. To break even, the sales price must cover the cost per unit. Prices that are greater than the cost per unit result in profits, whereas prices that are less than the cost per unit result in losses.

Types of Production Costs

Production incurs both fixed costs and variable costs. For example, fixed costs for manufacturing an automobile would include equipment as well as workers' salaries. As the rate of production increases, fixed costs remain steady.

Variable costs increase or decrease as production volume changes. Utility expenses are a prime example of a variable cost, as more energy is generally needed as production scales up.

The marginal cost of production refers to the total cost to produce one additional unit. In economic theory, a firm will continue to expand the production of a good until its marginal cost of production is equal to its marginal product (marginal revenue). This, in turn, will tend to equal its selling price.

In short, production costs definitely include SALARIES which is the cost of labor. If the minimum wage increases then so must the cost of goods and services. It's really common sense that when salaries increase - the cost of production ALSO INCREASES. Anything that leads to an increase in the cost of production will naturally lead to an increase in the cost of the FINISHED PRODUCT or SERVICE. The finance department of any company will compute the overall costs that should determine how much overhead costs will be added to keep up with the production.

It would be common sense to tell you that selling at a loss is financial suicide. How can a company operate if it pays its employees high while selling its products too low to recover? In business, a lower price can attract customers but quality also matters. Sometimes, a higher price is required to generate some profits. Profits are needed by companies to keep them operating. Even charities have to do some commercial activities like selling food and fundraising to keep them going. Charities even need to carefully calculate how much money they have left from fundraising and donations so they can continue running. If a company doesn't raise its prices to a certain extent then how can it keep its operations going? If a restaurant doesn't start raising its prices because they were improving on the quality of the food - how can they continue to serve better food?

What then eventually leads to a decrease in costs in goods and services?

The one thing that will eventually lead to a decrease in prices is called the economies of scale. This is tied to the basic economic law of supply and demand. If supply is up and demand is low - the prices will go low. The increasing number of supplies or the company's ability to be able to produce more for less is what will cause a decrease in goods and services to a certain extent. The company will still be able to pay high salaries as the decrease in cost is caused by other factors. The company might be able to reduce the other related costs such as purchasing of materials, manufacturing costs, and other related costs. If more can be produced for lesser cost then the cost of services can be lowered. It's because earlier costs were already covered up. However, the prices aren't lowered to an extent that they would be selling at financial suicide. 

What Are Economies of Scale?

Economies of scale are cost advantages reaped by companies when production becomes efficient. Companies can achieve economies of scale by increasing production and lowering costs. This happens because costs are spread over a larger number of goods. Costs can be both fixed and variable.

KEY TAKEAWAYS

• Economies of scale are cost advantages companies experience when production becomes efficient, as costs can be spread over a larger amount of goods.
• A business's size is related to whether it can achieve an economy of scale—larger companies will have more cost savings and higher production levels.
• Economies of scale can be both internal and external. Internal economies are caused by factors within a single company while external factors affect the entire industry. 

Understanding Economies of Scale

The size of the business generally matters when it comes to economies of scale. The larger the business, the more the cost savings. Economies of scale can be both internal and external. Internal economies of scale are based on management decisions, while external ones have to do with outside factors.

Internal functions include accounting, information technology, and marketing. The first two reasons are also considered operational efficiencies and synergies. The second two reasons are cited as benefits of mergers and acquisitions.

Economies of scale are an important concept for any business in any industry and represent the cost-savings and competitive advantages larger businesses have over smaller ones.

Most consumers don't understand why a smaller business charges more for a similar product sold by a larger company. That's because the cost per unit depends on how much the company produces. Larger companies can produce more by spreading the cost of production over a larger amount of goods. An industry may also be able to dictate the cost of a product if several different companies are producing similar goods within that industry.

There are several reasons why economies of scale give rise to lower per-unit costs. First, specialization of labor and more integrated technology boost production volumes. Second, lower per-unit costs can come from bulk orders from suppliers, larger advertising buys, or lower costs of capital. Third, spreading internal function costs across more units produced and sold helps to reduce costs.

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Hopefully, this basic COMMON SENSE post will clear things up. You don't need a doctorate in economics to understand the absurdity of the demands of Filipino communists.