26
Copyright 2002, Pearson Education Canada 1 The Behaviour of Profit- Maximizing Firms and the Production Process Chapter 7
| Date post: | 15-Jan-2016 |
| Category: |
Documents |
| View: | 213 times |
| Download: | 0 times |
Copyright 2002, Pearson Education Canada1
The Behaviour of Profit-Maximizing Firms and the Production Process
Chapter 7
Copyright 2002, Pearson Education Canada2
Firm and Household Decisions (Figure 7.1)
Copyright 2002, Pearson Education Canada3
Production
Production may be defined as the process by which inputs are combined, transformed, and turned into outputs.
Copyright 2002, Pearson Education Canada4
Perfect Competition
Perfect competition is an industry structure or market organization 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.
Copyright 2002, Pearson Education Canada5
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.
Copyright 2002, Pearson Education Canada6
Homogeneous Product
Homogeneous products are undifferentiated products; products that are identical to, or indistinguishable from, one another.
Copyright 2002, Pearson Education Canada7
Easy Entry and Easy Exit
Easy entry is the condition that exists when there are no barriers to prevent new firms from competing for profits in a profitable industry.
Easy exit is the condition that exists when firms can simply stop producing their product and leave a market. Firms incur no additional costs by exiting the industry.
Copyright 2002, Pearson Education Canada8
Demand Facing a Single Firm in a Perfectly Competitive Market (Figure 7.2)
If a representative firm in a perfectly competitive industry raises the price of its output above $2.45, the quantity demanded of that firms output will drop to zero. Each firm faces a perfectly elastic demand curve, d.
Copyright 2002, Pearson Education Canada9
The Three Decisions All Firms Make
How much output to supply (quantity of product)
How to produce that output (which production technology to use)
How much of each input to demand
Copyright 2002, Pearson Education Canada10
Profit = Total Revenue (TR) - Total Cost (TC)
Where Total Revenue is the receipts from the sale of a
product (P x q)
Profit
Profit is the difference between total revenue and total costs.
Copyright 2002, Pearson Education Canada11
Normal Rate of Profit or Normal Rate of Return
The normal rate of profit is a rate of profit that is just sufficient to keep owners or investors satisfied. For relatively risk-free firms, it should be nearly the same as the interest rate on risk-free government bonds.
Profits over and above the normal rate of return on investment are called economic profits or excess profits.
Copyright 2002, Pearson Education Canada12
Calculating Total Revenue, Total Cost and Profit For a Small Belt Firm (Table 7.1)
Copyright 2002, Pearson Education Canada13
Short Run vs. Long Run
The short run is a period of time for which two conditions hold: The firm is operating under a fixed scale (fixed factor)
of production Firms can neither enter or exist an industry
The long run is a period of time for a firm such that there are no fixed factors of production. Firms can increase or decrease the scale of production New firms can enter and existing firms can exit the
industry
Copyright 2002, Pearson Education Canada14
The Bases of Firm Decision Making
The market price of outputThe techniques of production that are
availableThe prices of inputs
Copyright 2002, Pearson Education Canada15
Determining the Optimal Method of Production to Maximize Profits (Figure 7.4)
Copyright 2002, Pearson Education Canada16
The Production Process
Production technology is the relationship between inputs and outputs.
The optimal method of production, for a profit-maximizing firm, is the one that minimizes costs.
Labour-intensive technology is technology that relies heavily on human labour rather than capital.
Capital-intensive technology is technology that relies heavily on capital rather than human labour.
Copyright 2002, Pearson Education Canada17
Production Function or Total Product Function
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.
Copyright 2002, Pearson Education Canada18
Marginal Product and Average Product
Marginal product is the additional output that can be produced by adding one more unit of a specific input, ceteris paribus.
The average product is the average amount produced by each unit of a variable factor of production.
Copyright 2002, Pearson Education Canada19
Law of Diminishing Returns
The law of diminishing returns states that when additional units of an input are added to fixed inputs after a certain point, the marginal product of the variable input declines.
Copyright 2002, Pearson Education Canada20
Labor Total Marginal AverageUnits Product Product Product0 0 --- ---1 10 10 10.02 25 15 12.53 35 10 11.74 40 5 10.05 42 2 8.46 42 0 7.0
Production Function (Sandwich Making) (From Table 7.2)
Copyright 2002, Pearson Education Canada21
Production Function for Sandwiches: Total Product (Figure 7.5)
Copyright 2002, Pearson Education Canada22
Typical Production Function (Figure 7.6)
Marginal and average product curves can be derived from total product curves.
The marginal product of labour is the slope of the total product curve.
Average product follows marginal product; it rises when marginal product is above it and falls when marginal product is below it.
Copyright 2002, Pearson Education Canada23
Choice of Technology
Two things determine the cost of production: The technologies that are available Input prices
Profit maximizing firms will choose the technology that minimizes the cost of production given current market input prices.
Copyright 2002, Pearson Education Canada24
Example of Technology Choice for a Diaper Company (Tables 7.3 & 7.4)
Five technologies are available to produce 100 diapers. The choice of technology is based upon relative input prices.
Copyright 2002, Pearson Education Canada25
Review Terms & Concepts
average product capital-intensive
technology easy entry easy exit economic profits or
excess profits firm homogeneous products
labour-intensive technology
law of diminishing returns
long run marginal product normal rate of profit or
normal rate of return optimal method of
production
Copyright 2002, Pearson Education Canada26
Review Terms & Concepts(continued)
perfect competition production production function or
total product function production technology profit short run total revenue
