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The Production Process
The Behavior of Profit-Maximizing Firms
Muhammad Umair Khan
Resource person: Mr.Mubeen Butt
THE PRODUCTION PROCESS
 PRODUCTION The process by which inputs are combined, transformed,
and turned into outputs.
 Prod...
The Behavior of Profit-Maximizing
Firms
 All firms must make several basic decisions to achieve what we assume to
be thei...
The Behavior of Profit-Maximizing
Firms
 Profits and Economic Costs difference
 profit (economic profit) The difference ...
The Behavior of Profit-Maximizing
Firms
 Normal Rate of Return
 normal rate of return A rate of return on capital that i...
Short-Run Versus Long-Run
Decisions
short run
The period of time for which two conditions hold: The firm is operating
unde...
The Behavior of Profit-Maximizing
Firms
 perfect competition :
An industry structure in which there are many firms, each ...
Competitive Firms are Price Takers
In a perfectly competitive market, individual firms are price-takers. This means
that f...
The Behavior of Profit-Maximizing
Firms
The Bases of Decisions: Market Price of Outputs, Available Technology, and Input P...
The Behavior of Profit-Maximizing
Firms
optimal method of production : The production method that minimizes
cost.
How the Production Process Starts
 PRODUCTION TECHNOLOGY:
The quantitative relationship between inputs and outputs.
 LAB...
PRODUCTION FUNCTIONS:
TOTAL PRODUCT
MARGINAL PRODUCT
AVERAGE PRODUCT
 MARGINAL PRODUCT
The additional output that can be ...
The Production Process
 Production Functions: Total Product, Marginal Product, And Average
Product
 production function ...
law of diminishing returns
 law of diminishing returns
When additional units of a variable input are added to fixed input...
The Production Process
T
T.P
M.P
Graphical representation
 Total Production
 Average Production
 Marginal Production
Law of Variable Proportion
Iso Quant/Equal Product
Curve/Production Indifference Curve
 An isoquant curve in two dimensions represents all combinati...
Table
Out put Pairs L K MRTSLK =
dk/dl
1000
1000
1000
1000
1000
I
Ii
Iii
Iv
V
1
2
3
4
5
16
12
9
7
6
4/1=4
3/1=3
2/1=2
1/1=...
ISOQUANT MAP
Capital & labour ratio
LABOUR
C
A
P
I
T
A
L
MARGINAL RATE OF TECHNICAL
SUBSTITUTION
(MRTSLK = dk /dl)
Rate of...
Iso cost Line
 “Iso cost line is a curve which shows different combinations of two factors like labor and
capital which a...
Equilibrium of ISO Quant curve
(Minimization of cost subject to output constraint)
“A firm be in equilibrium when the lowe...
Equilibrium of ISO Quant curve
Maximization of output subject to cost constraint
A firm will be in equilibrium where an is...
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Production behaviour

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Production behaviour

  1. 1. The Production Process The Behavior of Profit-Maximizing Firms Muhammad Umair Khan Resource person: Mr.Mubeen Butt
  2. 2. THE PRODUCTION PROCESS  PRODUCTION The process by which inputs are combined, transformed, and turned into outputs.  Production Is Not Limited to Firms  FIRM 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.
  3. 3. The Behavior of Profit-Maximizing Firms  All firms must make several basic decisions to achieve what we assume to be their primary objective—maximum profits Note: The Three Decisions That All Firms Must Make
  4. 4. The Behavior of Profit-Maximizing Firms  Profits and Economic Costs difference  profit (economic profit) The difference between total revenue and total cost. profit = total revenue - total cost  total revenue The amount received from the sale of the product (q x P).
  5. 5. The Behavior of Profit-Maximizing Firms  Normal Rate of Return  normal rate of return 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.
  6. 6. Short-Run Versus Long-Run Decisions short run The period of time for which two conditions hold: The firm is operating under a fixed scale (fixed factor) of production, and firms can neither enter nor exit an industry. long run That period of time for which there are no fixed factors of production: Firms can increase or decrease the scale of operation, and new firms can enter and existing firms can exit the industry.
  7. 7. The Behavior of Profit-Maximizing Firms  perfect competition : 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: Undifferentiated products; products that are identical to, or indistinguishable from, one another.
  8. 8. 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.
  9. 9. The Behavior of Profit-Maximizing Firms The Bases of Decisions: Market Price of Outputs, Available Technology, and Input Prices  In the language of economics, I need to know three things:  1. The market price of output  2. The techniques of production that are available  3. The prices of inputs  Output price determines potential revenues. The techniques available tell me how much of each input I need, and input prices tell me how much they will cost. Together, the available production techniques and the prices of inputs determine costs.
  10. 10. The Behavior of Profit-Maximizing Firms optimal method of production : The production method that minimizes cost.
  11. 11. How the Production Process Starts  PRODUCTION TECHNOLOGY: The quantitative relationship between inputs and outputs.  LABOR-INTENSIVE TECHNOLOGY: Technology that relies heavily on human labor instead of capital.  CAPITAL-INTENSIVE TECHNOLOGY: Technology that relies heavily on capital instead of human labor.
  12. 12. PRODUCTION FUNCTIONS: TOTAL PRODUCT MARGINAL PRODUCT AVERAGE PRODUCT  MARGINAL PRODUCT The additional output that can be produced by adding one more unit of a specific input, ceteris paribus.  AVERAGE PRODUCT : The average amount produced by each unit of a variable factor of production. total product average product of labor total units of labor 
  13. 13. The Production Process  Production Functions: Total Product, Marginal Product, And Average Product  production function or total product function 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.
  14. 14. law of diminishing returns  law of diminishing returns When additional units of a variable input are added to fixed inputs after a certain point, the marginal product of the variable input declines. Note:  Diminishing returns always apply in the short run, and in the short run every firm will face diminishing returns. This means that every firm finds it progressively more difficult to increase its output as it approaches capacity production
  15. 15. The Production Process T T.P M.P
  16. 16. Graphical representation  Total Production  Average Production  Marginal Production Law of Variable Proportion
  17. 17. Iso Quant/Equal Product Curve/Production Indifference Curve  An isoquant curve in two dimensions represents all combinations of two inputs that produce the same quantity of output.  The word “iso”means same  while “quant” stand for quantity Production Indifference Curve: Isoquants represent combinations of inputs that yield the same level of production Q=f(L&K)
  18. 18. Table Out put Pairs L K MRTSLK = dk/dl 1000 1000 1000 1000 1000 I Ii Iii Iv V 1 2 3 4 5 16 12 9 7 6 4/1=4 3/1=3 2/1=2 1/1=1 dL=1 dk=4
  19. 19. ISOQUANT MAP Capital & labour ratio LABOUR C A P I T A L MARGINAL RATE OF TECHNICAL SUBSTITUTION (MRTSLK = dk /dl) Rate of change in capital with respective to Rate of change in Laour is called MRTSlk ok1-ok2/ol1-ol2=16-12/1-2 = -4(negative slope of IQ )
  20. 20. Iso cost Line  “Iso cost line is a curve which shows different combinations of two factors like labor and capital which a firm can purchase while the firm budget cost, price of labour and price of capital are given”
  21. 21. Equilibrium of ISO Quant curve (Minimization of cost subject to output constraint) “A firm be in equilibrium when the lowest iso cost is tangent to the given given iso quant curve” PL/Pk=dk/dl (equilibrium condition)
  22. 22. Equilibrium of ISO Quant curve Maximization of output subject to cost constraint A firm will be in equilibrium where an iso cost line is tangent to the highest iso Quant curve. Necessary condition apply: PL/Pk=dk/dl (equilibrium condition)

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