Topics
▪ The Ownership and Management of Firms.
▪ Production.
▪ Short-Run Production: One Variable and One Fixed
Input.
▪ Long-Run Production: Two Variable Inputs.
▪ Returns to Scale.
▪ Productivity and Technical Change.
1
What is a firm?
▪ Firm - an organization that converts
inputs such as labor, materials, energy,
and capital into outputs, the goods and
services that it sells.
Sole proprietorships are firms owned and
run by a single individual.
Partnerships are businesses jointly owned
and controlled by two or more people.
Corporations are owned by shareholders in
proportion to the numbers of shares of stock
they hold.
2
What Owners Want?
▪ Main assumption: firm’s owners try to
maximize profit!
▪ Profit (π) - the difference between
revenues, R, and costs, C:
π=R–C
3
What are the categories of inputs?
▪ Capital (K) - long-lived inputs.
land, buildings (factories, stores), and equipment
(machines, trucks)
▪ Labor (L) - human services
managers, skilled workers (architects, economists,
engineers, plumbers), and less-skilled workers
(custodians, construction laborers, assembly-line
workers)
▪ Materials (M) - raw goods (oil, water, wheat)
and processed products (aluminum, plastic,
paper, steel)
4
How firms combine the inputs?
▪ Production function - the relationship
between the quantities of inputs used
and the maximum quantity of output that
can be produced, given current
knowledge about technology and
organization
5
Production Function
Production
Inputs Function Output
(L, K) q
q = f(L, K)
▪ Formally,
q = f(L, K)
where q units of output are produced using L units
of labor services and K units of capital (the number
of conveyor belts).
6
Time and the Variability of Inputs
▪ Short run - a period of time so brief that at
least one factor of production cannot be varied
practically
Fixed input - a factor of production that cannot be
varied practically in the short run.
Variable input - a factor of production whose
quantity can be changed readily by the firm during
the relevant time period
▪ Long run - a lengthy enough period of time
that all inputs can be varied
7
Short-Run Production
▪ In the short run, the firm’s production
function is
q = f(L, K)
where q is output, L is workers, and K is the
fixed number of units of capital.
8
Table 6.1 Total Product, Marginal Product, and
Average Product of Labor with Fixed Capital
9
Marginal Product of Labor
▪ Marginal product of labor (MPL ) - the change
in total output, Δq, resulting from using an extra
unit of labor, ΔL, holding other factors constant:
Δq
MPL =
ΔL
10
Average Product of Labor
▪ Average product of labor (APL ) - the ratio of
output, q, to the number of workers, L, used to
produce that output:
q
APL =
L
11
Total Product of Labor
▪ Total product of labor- the amount of
output (or total product) that can be
produced by a given amount of labor
12
Figure 6.1 (a)
Output, q, Units per day
C
110
Production
Relationships
90 B
with Variable 56
Labor
A
Diminishing Marginal
Returns sets in! 0 4 6 11
L, Workers per day
(b)
a
APL, MPL
20
b
15
Average product, APL
Marginal product, MPL
c
0 4 6 11
L, Workers per day
13
Law of Diminishing Marginal Returns
If a firm keeps increasing an input, holding
all other inputs and technology constant,
the corresponding increases in output
will become smaller eventually.
That is, if only one input is increased, the
marginal product of that input will diminish
eventually.
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