© 2003 McGraw-Hill Ryerson Limited. Production and Cost Production and Cost Analysis I Analysis I Chapter 9 Chapter 9 © 2003 McGraw-Hill Ryerson Limited 9 - 2 Introduction Introduction  In the supply process, people first offer the factors of production they control to the market.  Then the factors are transformed by firms into goods that consumers want.  Production occurs when factors of production (inputs) transform into goods and services. © 2003 McGraw-Hill Ryerson Limited 9 - 3 The Role of the Firm The Role of the Firm  A firm is an economic institution that transforms factors of production into consumer goods and services. © 2003 McGraw-Hill Ryerson Limited 9 - 4 The Role of the Firm The Role of the Firm  A firm:  Organizes factors of production.  Produces goods and services.  Sells produced goods to individuals, businesses or government. © 2003 McGraw-Hill Ryerson Limited 9 - 5 The Firm and the Market The Firm and the Market  A firm operates within the market and, simultaneously, it abandons the market in the sense that it replaces the market with command and control. © 2003 McGraw-Hill Ryerson Limited 9 - 6 The Firm and the Market The Firm and the Market  How an economy operates depends on transaction costs—costs of undertaking trades through the market. © 2003 McGraw-Hill Ryerson Limited 9 - 7 Firms Maximize Profit Firms Maximize Profit  Firm’s goal is to maximize profit.  Profit is the difference between total revenue and total cost. Profit = Total revenue – Total cost © 2003 McGraw-Hill Ryerson Limited 9 - 8 Firms Maximize Profit Firms Maximize Profit  An accountant will calculate profit by subtracting explicit costs from the revenue.  For an economist,the measure of profit is revenues minus both implicit and explicit costs. © 2003 McGraw-Hill Ryerson Limited 9 - 9 Firms Maximize Profit Firms Maximize Profit  Implicit costs include the opportunity costs of the factors of production. Economic profit = Revenue – (Implicit costs +Explicit costs) © 2003 McGraw-Hill Ryerson Limited 9 - 10 The Production Process The Production Process  The production process is generally divided into a long run planning decision and the short run adjustment decision. [...]... Productivity This means that initially the production function exhibits increasing marginal productivity Then it exhibits diminishing marginal productivity Eventually, the production function exhibits negative marginal productivity © 2003 McGraw-Hill Ryerson Limited 9 - 26 The Law of Diminishing Marginal Productivity The most important part of the production function is the part exhibiting diminishing... productivity Diminishing marginal productivity Diminishing absolute productivity © 2003 McGraw-Hill Ryerson Limited 9 - 23 A Production Function, Figure 9-1b 32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 Diminishing marginal productivity Diminishing absolute 7 productivity 6 TP Increasing marginal productivity Diminishing marginal productivity Diminishing absolute productivity 5 Output per worker Output and. .. Marginal and average product 8 9 MP 10 © 2003 McGraw-Hill Ryerson Limited 9 - 24 The Law of Diminishing Marginal Productivity The law of diminishing marginal productivity is an important element in all real-world production processes Both marginal and average productivities initially increase, but eventually they both decrease © 2003 McGraw-Hill Ryerson Limited 9 - 25 The Law of Diminishing Marginal... diminishing marginal productivity and falling average product © 2003 McGraw-Hill Ryerson Limited 9 - 27 The Law of Diminishing Marginal Productivity The law of diminishing marginal productivity states that as more and more of a variable input is added to an existing fixed input, after some point the additional output obtained from the additional input will fall © 2003 McGraw-Hill Ryerson Limited 9 - 28... resulting from various combinations of factors of production or inputs © 2003 McGraw-Hill Ryerson Limited 9 - 17 Production Tables and Production Functions Most of the production decisions firms make are short run decisions involving changes in output at a given production facility The firm can increase or decrease production by adjusting the amount of variable inputs, such as labour or materials ©... dividing total output by the number of workers who produced it © 2003 McGraw-Hill Ryerson Limited 9 - 20 Production Tables and Production Functions The information in a production table is often summarized in a production function – a curve that describes the relationship between the inputs (factors of production) and outputs © 2003 McGraw-Hill Ryerson Limited 9 - 21 Production Tables and Production. .. of Diminishing Marginal Productivity This law is also called the flowerpot law, because it if did not hold true, the world’s entire food supply could be grown in a single flower pot © 2003 McGraw-Hill Ryerson Limited 9 - 29 The Costs of Production Costs of production in the short run are: Fixed Costs, Variable Costs, and Total Costs © 2003 McGraw-Hill Ryerson Limited 9 - 30 Fixed Costs, Variable Costs,... Run and the Short Run A long-run decision is a decision in which the firm can choose the least expensive method of producing from among all possible production techniques © 2003 McGraw-Hill Ryerson Limited 9 - 12 The Long Run and the Short Run A short-run decision is one in which the firm is constrained by past choices in regard to what production decisions it can make © 2003 McGraw-Hill Ryerson Limited... Ryerson Limited 9 - 32 Fixed Costs, Variable Costs, and Total Costs The sum of the variable and fixed costs are total costs: TC = FC + VC © 2003 McGraw-Hill Ryerson Limited 9 - 33 The Costs of Production Besides total costs, firms are concerned with their costs per unit of output Per unit costs are Average Total Cost, Average Fixed Cost, and Average Variable Cost © 2003 McGraw-Hill Ryerson Limited 9 -... The Long Run and the Short Run In the short run: Flexibility is limited Some factors of production cannot be changed Generally, the production facility (“the plant”) is fixed in the short run © 2003 McGraw-Hill Ryerson Limited 9 - 16 Production Tables and Production Functions How a firm combines factors of production to produce consumer goods can be presented in a production table A production table shows . McGraw-Hill Ryerson Limited. Production and Cost Production and Cost Analysis I Analysis I Chapter 9 Chapter 9 © 2003 McGraw-Hill Ryerson Limited 9 - 2 Introduction Introduction  In. Maximize Profit  Implicit costs include the opportunity costs of the factors of production. Economic profit = Revenue – (Implicit costs +Explicit costs) ©