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Chapter 5: The Profit Maximizing Firm

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Kaye Anne Servigon

on 12 September 2012

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Transcript of Chapter 5: The Profit Maximizing Firm

Chapter 5: THE PROFIT MAXIMIZING FIRM refers to any economic activity, which combines the four factors of production (i.e., land, labor, capital and entrepreneurship) to form an output which will give direct satisfaction to the consumer
is the process of converting inputs into outputs These are commodities and services that are used to produce goods and services. Land natural resources
represents the gift of nature to our productive processes Labor is the mental and physical ability used in the production of goods and services Capital goods that are used in the production of other goods and services
This includes machines, equipments, buildings, factories, roads, etc. These are various useful goods and services that result from the production process and are either consumed or employed in further production. Production Inputs Outputs Final goods goods and services that are ultimately consumed Intermediate goods goods that are used to produce others goods Technology is the body of knowledge applied to how goods are produced
is the production process employed by firms in creating goods and services Labor Intensive Technology utilizes more labor resources than capital resources
is usually employed by economies where labor resources are abundant and cheap
In the case of the Philippines, industries that are considered labor intensive include the agricultural sector and some manufacturing sub-sectors like garments. Capital Intensive Technology utilizes more capital resources than labor resources
is employed by industrialized economies since capital resources in these economies are cheaper than labor
Countries such as Germany, Japan, Korea and the United States are considered capital intensive economies. The decision to use what type of technology to employ depends upon the availability of the resource and its cost. Thus, if more labor is available in most cases industries will be more labor intensive since cost of labor will be cheaper than the use of capital. On the other hand, if capital is more abundant while labor is scarce, then industries will be more capital intensive since capital will be cheaper to acquire. is any resource the quantity of which cannot readily be changed when market conditions indicate that a change in output is desirable
These cannot easily be changed within a short period of time thus they must remain as fixed amounts while managers decide to vary output.
Examples of fixed input include the plant and buildings that the firm uses as well as the machinery and equipment.
INPUT VARIABLE INPUT is any economic resource the quantity of which can be readily changed in response to changes in output
For instance, managers can hire fewer or more workers during a given period. They can also change the amount of materials used in production. Two types of inputs SHORT RUN is a period of time so short that there is at least one fixed input therefore changes in the output must be accomplished exclusively by changes in the use of variable inputs LONG RUN is a period of time so long that all inputs are considered variable
known as the ‘planning horizon’ Production Function is the functional relationship between quantities of inputs used in production and outputs to be produced For instance, in making a dress, its production
function may appear as follows:

Q dress = f (Fabrics, Sewing machine, Sewer, Thread, Buttons, etc.)

Three important production concepts Total Product Marginal Product Average Product Total Product
refers to the total output produced after utilizing the fixed and variable inputs in the production process Marginal Product
is the extra output produced by one additional unit of an input while other inputs are held constant
Marginal means ‘extra’ or ‘additional’
MP = Change in TP / Change in IL
Average Product
Total product divided by total units of input used Law of Diminishing Returns - holds that we will get less and less extra output when we add additional amount of an input while holding other inputs fixed Constant returns to scale indicate a case when a change in all inputs leads to a proportional change in output Increasing returns to scale also called ‘economies of scale’
happen when an increase in all inputs leads to a more-than-proportional increase in the level of output Decreasing returns to scale - occur when a balanced increase in all inputs leads to a less-than-proportional increase in total output Cost refers to all expenses acquired during the economic activity or the production of goods and services
Profit = Sales – Costs or
Profit = Total Revenue – Total Costs Explicit Cost payments to non-owners of a firm for their resources
expenses made for the use of resources not owned by the firm itself
Examples are wages paid to labor, mental changes, cost of electricity, phone bills, cost of raw materials, etc. Implicit Cost opportunity cost of using resources owned by the firm
opportunity costs of resources because the firm makes no actual payment to outsiders
There is no payment to anyone because you gave up the opportunity to earn rental payment for your vacant room. Fixed Cost overhead/ supplementary cost
are those expenses which are spent for the use of fixed factors of production
it stay the same no matter how much output changes
sometimes called sunk cost
Examples are rent, interest and expenses on machines, depreciation, etc. Variable Cost prime/ operating cost
are those expenses which change as a consequence of a change in quantity of output produced
those costs which are incurred on variable factor inputs
Examples are expenses on labor inputs, raw materials, electricity, fuel, etc.
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