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Understanding how firms maximize profits by optimizing the relationship between inputs and outputs in the production function. Exploring concepts like total revenue, total costs, marginal product, and the law of diminishing marginal product. Learn how productivity improvements lead to cost reduction and increased profits.
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The Production Function Chapter 13
Maximum Profits Firm Behavior • Firm’s have an economic goal to maximize profit • Profit=Total Revenue – Total Costs • Producing at unit elasticity only maximizes total revenue • To maximize profit firms focus on ↓ costs of production • If costs ↓ =>Profit ↑ Productivity ↑ => Costs ↓ => Profit ↑
Production Function OUTPUT Known as Total Product (output) Production Function • Production Function-measuresthe relationship between Qty of inputsand Qty of output Inputs: Labor Capital (human & physical) Natural Resources Entrepreneurial Talent
Gain 5 more computers Marginal Product (output) • Marginal product - the increase in output that arises from one additional unit of input Add 1 worker Goal is to ↑ productivity (efficiency) of workers Then costs ↓ => profit rises!
Law of Diminishing Marginal Product • As firms add inputs—at some point----marginal product (MP)will begin to decline • Example: As more and more workers are hired => eventually each additional worker contributes less output 10 16 20 30 20 MP = # T-Shirts per worker 8
The slope of the production function measures the marginal product of the next input Quantity of output Total Product = Total Output As marginal productdeclines, the production function becomes flatter Number of Workers Hired
Production Function Graph TP Once MP turns negative => TP begins to decline AP MP
Worksheet #1 • Lesson 2, Activity 25 pg. 131
