Input, Output The theory of cost Opportunity Cost Returns to Scale Important Production Concepts Four factors of production

1. CHAPTER 5
The profit maximizing firm

2. Production
It refers to any economic activity,which combinesthe
four factors ofproduction.
1. Land
2. Labor
3. Capital
4. Entrepreneurship
It isthe process ofconverting inputsinto outputs.

3. Inputs– commoditiesand services that are used to
produces goods andservices.
1. Land (natural resources, represents the gift of
nature to ourproductive processes.

4. 2. Labor ( mental and physicalabilityused inthe
productionof goods andservices.
3. Capital( goodsthat are used inthe production
of other goodsand services.

5. Outputs –various useful goodsand services
that result from the productionprocessand are
eitherconsumed oremployed infurther
production.

6. 1. Finalgoods- goods
and servicesthat are
ultimatelyconsumed.
Ex. Clothesthat
we wear

7. 2. Intermediategoods
- goodsthat areused
to produceothergoods.
Ex. Sugar in the making
of cakes

8. Technology
- a body of knowledgeappliedto how goods
areproduced.
1. Labor Intensive Technology
- utilizes
more labor
resources

9. 2. Capital Intensive Technology
-utilizes more capital resources

10.  Fixedinput-isany resource the quantityof which cannot
be readilychanged when market conditionsindicatethat a
change in output is desirable.
Variableinput– is any economic resource the quantityof
whichcan be readily changed inresponse to changes in
output.

11. ShortRun – a period oftime so short that there is at least
one fixedinputtherefore changes in the output must be
accomplishedexclusivelyby changes in the use of variable
inputs.
Long run - a periodof time so long that allinputsare
consideredvariable. It is alsoknown as the planning
horizon.

12. ProductionFunction
It is the functional relationship between quantities of
inputs used in production and outputs to be produced. The
production function specifies the maximum output that can
be produced with a given quantity of inputs given the
available technology.

13. Important Production
Concepts

14.  Totalproduct – refers to the total output produced after
utilizing the fixed and variable inputs in the production
process.
 Average Product – which equals total product divided by
total units of input used.
 Marginal Product of an input- the extra output produced by 1
additional unit ofan input while other inputs are held
constant.

15.  Labor’s MarginalProduct -the extraor additional output
obtainedby adding 1 unit of labor.
Wecan derive marginalproduct usingthefollowing equation:
MP =
∆TP
∆I1. MP=
TP2-TP1
IL2-IL1

16. Graphical Representation of Total Product, Marginal Product and Average
Product

17. This figure shows thetotal, marginaland
averageproducts. Totalproductincreasesat a
decreasingratewhilemarginaland average
products first increase,reachtheir maximum and
thereafterdecline.

18. holdsthat we willget lessand less extra output when we add
additional amountof an input whileholdingother inputsfixed.
In other words, the marginalproduct ofeach unitof inputwill
declineas the amount ofthatinput increases,holdingall other
inputsconstant.
The Law of Diminishing Returns

19. Diminishingreturns and
marginal products refer to the
response of output to an increase of a
single inputwhen all otherinputs are
heldconstant.
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20. Constant Returns to
Scale
Increasing Returns to
Scale
Decreasing Returns
to Scale
Indicate a case where a changein all inputs leads to a
proportional change in output.
Also called as economiesofscale.It happens when an
increase inall inputs leads to a more-than-proportional
increase inthe level of output.
It occurs when a balanced increase in all inputs leads to a
less-than-proportional increase in total output.

21. The theory of cost
Cost refers toallexpenses acquired during the economic activity
or the production of goods andservices.
Sales–Cost = Profit
TotalRevenue–Total Costs= Profit

22. TotalOpportunitycost- sum of explicit andimplicit
cost.
ExplicitCost are payments to non-owners of a firm
for their resources.
ImplicitCost are the opportunityof costsof using
resources owned by a firm.

23. Fixedcost or overheard or supplementary cost are
those expenseswhich are spent for the use of fixed
factors of production.It is sometimes called sunkcosts.
Example:Rent, Interest, Depreciation

24. Variable Cost or prime operating cost are those
expenses which change as a consequenceof a change
in quantity of outputproduced.
These includeexpenses on labor inputs, raw materials,
electricity, etc.

25. Cost
Total variable cost (TVC)– consists of costs that
are zero whenoutputis zero and vary as output
increases or decreases.
Total fixed cost (TFC) – consists of costs thatdo
not vary as outputvaries and thatmustbe paid
even if outputis zero.

26. Total Cost
sum of total fixedcost andtotal variable cost.
TC =TFC + VC

27. Average FixedCost (AFC)
AFC = FC / Q
Average VariableCost (AVC)
AVC = VC / Q
Average TotalCost (ATC)
ATC = AFC+AVC or TC / Q
Average Cost: Average Fixed Cost, Average Variable Cost and
Average Total Cost

28. MarginalCost (MC)
The costof producingone additional unitof output.
The change in totalcostwhen one additional unitof
output isproduced.
MC = ∆TC
∆Q
MC = ∆TVC
∆Q

30. Profit– difference thatarises when a film’s totalrevenue is
greater than ofit’scost.
Profit Maximization– process by whicha firm determines
the price and outputlevel that returns the greatest profit.
Profit = Total Revenue– Total Cost