PRINCIPLE OF ECONOMIC
6 EDITION
KARL CASE, RAY FAIR
PRENTICE HALL BUSINESS PUBLISHING
COPY RIGHT 2002
Production
Central to our analysis is production:
•
Production
is the process by which inputs are combined, transformed, and turned into
outputs.
What Is A Firm?
•
A firm is an organization
that comes into being when a person or a group of people decides to produce a
good or service to meet a perceived demand.
Most firms exist to make a profit.
•
Production is not limited to firms.
Perfect Competition
Perfect competition is an industry structure in
which there are:
•
many firms,
each small relative to the industry,
•
producing virtually identical
products and
•
in which no firm is large
enough to have any control over prices.
•
In perfectly competitive industries, new
competitors can freely enter and exit the market.
Homogeneous Products
•
Homogeneous products
are undifferentiated products; products that are identical to, or
indistinguishable from, one another.
Competitive Firms are Price Takers
•
In a perfectly competitive market,
individual firms are price-takers. This means that firms have no control over
price. Price is determined by the
interaction of market supply and demand.
Profits and Economic Costs
•
Profit (economic profit)
is the difference between total revenue and total cost.
•
Total revenue
is the amount received from the sale of the product:
(q X P)
•
Total cost (total economic cost)
is the total of
1.
Out of pocket costs,
2.
Normal rate of return on capital, and
3.
Opportunity cost of each factor of
production.
Normal Rate of Return
•
The normal rate of return
is a rate of return on capital that is just sufficient to keep owners and
investors satisfied.
•
For relatively risk-free firms, it
should be nearly the same as the interest rate on risk-free government bonds.
Short-Run Versus Long-Run Decisions
•
The short run is a period
of time for which two conditions hold:
1.
The firm is operating under a fixed
scale (fixed factor) of production, and
2.
Firms can neither enter nor exit an
industry.
•
The long run is a period
of time for which there are no fixed factors of production. Firms can increase or decrease scale of
operation, and new firms can enter and existing firms can exit the industry.
The Production Process
•
Production technology
refers to the quantitative relationship between inputs and outputs.
•
A labor-intensive technology
relies heavily on human labor instead of capital.
•
A capital-intensive technology
relies heavily on capital instead of human labor.
•
The production function or
total product function is a numerical or mathematical expression
of a relationship between inputs and outputs.
It shows units of total product as a function of units of inputs.
The Law of Diminishing Marginal Returns
•
The law of diminishing marginal
returns states that:
When additional units of a variable
input are added to fixed inputs, the marginal product of the variable input
declines.
Total, Average, and Marginal Product
•
Marginal product is the slope of the
total product function.
•
At point A, the slope of the total
product function is highest; thus, marginal product is highest.
•
At point C, total product is maximum,
the slope of the total product function is zero, and marginal product
intersects the horizontal axis.
Total, Average, and Marginal Product
•
When a ray drawn from the origin falls
tangent to the total product function, average product is maximum and equal to
marginal product.
•
Then, average product falls to the left
and right of point B.
•
When a ray drawn from the origin falls
tangent to the total product function, average product is maximum and equal to
marginal product.
•
Then, average product falls to the left
and right of point B.
•
As long as marginal product rises,
average product rises.
•
When average product is maximum,
marginal product equals average product.
•
When average product falls, marginal
product is less than average product.
Production Functions with Two Variable Factors of
Production
•
In many production processes, inputs
work together and are viewed as complementary.
•
For example, increases in capital usage
lead to increases in the productivity of labor.
•
Given the technologies available, the
cost-minimizing choice depends on input prices
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