Production

1. Production Microeconomics What is Marketing? Principles of Marketing

2. Technology In an economics context, technology does not mean high tech, or having to do with computers or the internet. Rather, technology means the way, the process by which inputs are used to produce outputs. A different process means a different technology.

3. Cost is not Price From the firm’s perspective, cost is what they pay for the inputs necessary to produce the product. Price is what the firm receives for selling the product

4. Firms and Production • A firm (or business) combines inputs of labor, capital, land, and raw or finished component materials to produce outputs. If the firm is successful, the outputs are more valuable than the inputs. • This activity of production goes beyond manufacturing (i.e., making things). It includes any process or service that creates value, including transportation, distribution, wholesale and retail sales. 

5. Production Decisions Production involves a number of important decisions that define the behavior of firms. These decisions include, but are not limited to: • What product or products should the firm produce? • How should the products be produced (i.e., what production process should be used)? • How much output should the firm produce? • What price should the firm charge for its products? • How much labor should the firm employ?

6. Market Structure Market structure is a multidimensional concept that involves how competitive the industry is. It is defined by questions such as these: • How much market power does each firm in the industry possess? • How similar is each firm’s product to the products of other firms in the industry? • How difficult is it for new firms to enter the industry? • Do firms compete on the basis of price, advertising, or other product differences?

7. The Spectrum of Competition

8. The Factors of Production: Labor Labor is the human effort that can be applied to production, including workers and the unemployed. The amount of labor available to an economy can be increased in two ways: • increase the total quantity of labor, either by increasing the number of people available to work or by increasing the average number of hours of work per time period • increase the amount of human capital (skills) possessed by workers

9. Capital Any resource is capital if it satisfies two criteria: • The resource must have been produced • The resource can be used to produce other goods and services Firms can use money to acquire capital May include ideas

10. Natural Resources There are two essential characteristics of natural resources. • They are found in nature—that no human effort has been used to make or alter them • They can be used for the production of goods and services The natural resources available to us can be expanded in three ways: • discovery of new natural resources, • discovery of new uses for resources • discovery of new ways to extract natural resources in order to use them

11. Technology and Entrepreneurship • Technology is the knowledge that can be applied to the production of goods and services • An entrepreneur is a person who, operating within the context of a market economy, seeks to earn profits by finding new ways to organize factors of production

12. Long and Short Run • The short run in this microeconomic context is a planning period over which the managers of a firm must consider one or more of their factors of production as fixed in quantity • The planning period over which a firm can consider all factors of production as variable is called the long run • At any one time, a firm will be making both short-run and long-run choices

13. Fixed and Variable Costs • When the quantity of a factor of production cannot be changed during a particular period, it is called a fixed factor of production • A factor of production whose quantity can be changed during a particular period is called a variable factor of production; factors such as labor and food are examples

14. The Short Run Production Function A firm uses factors of production to produce a product. The relationship between factors of production and the output of a firm is called a production function

15. Total Product Curve A total product curve shows the quantities of output that can be obtained from different amounts of a variable factor of production, assuming other factors of production are fixed

16. Marginal Product Marginal product is the ratio of the change in output to the change in the amount of a variable factor. The marginal product of labor (MPL), for example, is the amount by which output rises with an additional unit of labor. It is thus the ratio of the change in output to the change in the quantity of labor (ΔQ/ΔL), all other things unchanged. It is measured as the slope of the total product curve for labor

17. Average Product The average product of a variable factor is the output per unit of variable factor. The average product of labor (APL), for example, is the ratio of output to the number of units of labor (Q/L)

18. From Total Product to the Average and Marginal Product of Labor Panel (a) shows the total product curve. The slope of the total product curve is marginal product, which is plotted in Panel (b). 

19. Law of Diminishing Marginal Returns The law of diminishing marginal returns holds that the marginal product of any variable factor of production will eventually decline, assuming the quantities of other factors of production are unchanged

20. Accounting Profit Accounting profit is a cash concept. It means total revenue minus explicit costs (payments made)—the difference between dollars brought in and dollars paid out Profit = Total Revenue – Total Cost Total revenue is the income brought into the firm from selling its products. It is calculated by multiplying the price of the product times the quantity of output sold: Total Revenue = Price x Quantity

21. Economic Profit Economic profit is total revenue minus total cost, including both explicit and implicit costs Implicit costs represent the opportunity cost of using resources already owned by the firm Economic Profit = Total Revenues – Explicit Costs – Implicit Costs

22. Fixed and Marginal Costs How Output Affects Total Costs At zero production, the fixed costs of $160 are still present. As production increases, variable costs are added to fixed costs, and the total cost is the sum of the two, Total cost = fixed cost + variable cost

23. Cost Curves

24. Sunk Costs Fixed costs are often sunk costs that cannot be recouped. In thinking about what to do next, sunk costs should typically be ignored, since this spending has already been made and cannot be changed

25. Why are total cost and average cost not on the same graph? Total cost, fixed cost, and variable cost each reflect different aspects of the cost of production over the entire quantity of output being produced. These costs are measured in dollars In contrast, marginal cost, average cost, and average variable cost are costs per unit

26. Average Cost and Marginal Cost Average cost tells a firm whether it can earn profits given the current price in the market. If we divide profit by the quantity of output produced we get average profit, also known as the firm’s profit margin. average profit=price−average cost The marginal cost of producing an additional unit can be compared with the marginal revenue gained by selling that additional unit to reveal whether the additional unit is adding to total profit—or not. Thus, marginal cost helps producers understand how profits would be affected by increasing or decreasing production

27. Relationship Between Short-Run and Long-Run Average Total Costs The LRAC curve is found by taking the lowest average total cost curve at each level of output.

28. Long Run Costs No costs are fixed in the long run. A firm can build new factories and purchase new machinery, or it can close existing facilities. In planning for the long run, the firm will compare alternative production technologies (or processes)

29. Production Choices • As an input becomes more expensive, firms will attempt to conserve on using that input and will instead shift to other inputs that are relatively less expensive • This pattern helps to explain why the demand curve for labor (or any input) slopes down • Physical capital and labor can often substitute for each other • Any change in the production process will cause a change in production cost • Long-run costs are usually less than short-run costs because you have more options

30. Economies of Scale Economies of scale exist because the larger scale of production leads to lower average costs

31. LRAC The five different short-run average cost (SRAC) curves each represents a different level of fixed costs, from the low level of fixed costs at SRAC1 to the high level of fixed costs at SRAC5. The long-run average cost (LRAC) curve shows the lowest cost for producing each quantity of output when fixed costs can vary, and so it is formed by the bottom edge of the family of SRAC curves

32. LRAC Curve and the Size and Number of Firms The shape of the long-run average cost curve has implications for how many firms will compete in an industry, and whether the firms in an industry have many different sizes, or tend to be the same size

33. Scale Scale matters for some industries, but not others.

34. Practice Question • How can there be economies of scale given the law of diminishing returns?

35. Quick Review • What is production? What is a production function? • What are marginal, average, and total product? How are they different? How do economists compute and graph marginal, average, and total product? • What is the difference between Explicit and Implicit Costs, Accounting and Economic Profit? • What are short run and long run costs? What is the difference between short-run and long-run costs?