Outline

• Production is the process of turning inputs into outputs.
• Inputs (the goods and services businesses use to create outputs) include:
• Labor refers to the hours of work supplied by the various types of workers that enable a business to function.
• Capital is the durable physical equipment and structures a business uses in the production process.
• Land
• Intermediate Inputs are the goods and services purchased from other businesses for immediate use in the production process.
• Business Know-How refers to all the knowledge and technology necessary for the production process.
• The Production Function represents the relationship between a given amount of inputs and how much output it will produce.
• Marginal Product of Labor represents the extra amount of output produced by one additional hour of labor (or additional worker).
• Holding all other inputs constant, each additional worker will have diminishing marginal product.
• Average Product is output divided by labor (or output per worker).
•  Cost is the money that a business pays for its imports.
• The Total Cost of Production =  (Labor Costs) +  (Costs of Capital and Labor) +  (Costs of Intermediate Inputs) +   (Costs of Simulating Business Know-How)
• Cost Function shows the relationship between a business’s output and its total cost.
• Marginal Cost is the extra added expense of producing one additional unit of output (change in cost divided by change in output).
• Variable Costs are costs that change in the short term.
• Fixed Costs are costs that do not change in the short term.
• Short-Term Cost Function examines the relationship between variable costs and output.
• Long-Term Cost Function examines the relationship between all costs (including fixed costs) and output.
• Revenue is the money that consumers pay for the output of a business.
• Marginal Revenue is the additional revenue earned by business for selling one additional unit of output.
• Profit Maximization
• In a market economy, the objective of business is to maximize profit.
• A business will increase its production as long as marginal revenue exceeds marginal costs.
• In short-run profit maximization, the focus is on the short-term cost function; and in the long-run profit maximization, the focus is on the long-term cost function, where all inputs can vary.

 

Common Myths & Common Problems

• Since businesses profit maximize, all they care about is greed.
• This is not necessarily the case. Businesses only make profit by selling products that consumers want and are willing to pay for; therefore, the only way they can make profit is by making consumers better off.
• Chief Executive Officers of large corporations are paid very high salaries, which is unfair.
• While it is true that they are paid very well, what most people do not understand is that the job is extremely difficult. In many cases, it is very difficult to consistently produce profit. In addition, the chief executive officer usually bears the burden of failure. Therefore, a high salary is necessary to attract well-qualified individuals to this position, where success is difficult to achieve and where they must bear enormous amount of risk (as evidenced by the high turnover rate).

 

• I don’t understand this chart:

• To find marginal product of labor, examine how much additional output is produced by the additional amount of labor. 
• For example, if we have one accountant we know that she can do 10 tax returns a week. However, if we had a second accountant they can produce 20 tax returns per week. The marginal product of the second accountant will be 20 – 10. This means the marginal product of labor for the second accountant is 10 additional tax returns. If we add a third accountant, output will increase to 29 tax returns per week. To find the marginal product of labor for the third accountant we will subtract 20 from 29 this means the additional number of tax returns produced by the additional accountant will be nine.

 

Real World Applications from an Economist’s Perspective

There is concern about the amount of profits made by some companies. Many people believe that the desire to earn profit is separate and distinct from the desire to help human beings. We tend to believe that earning profit is selfish, while helping others is community-oriented.  While this is one perspective, we need to understand the economist’s perspective. Remember, economic analysis is not opinion, but logical deduction based on objective analysis.

While it is true that firms that maximize profit tend to concern themselves with the bottom line, we need to take a broader look at what it is they actually do. We tend to forget that in order for firms to maximize profit, they must actually sell a product that consumers want. Remember that in the market, it takes two to tango; that means producers, by themselves, cannot accomplish anything and consumers, by themselves, cannot accomplish anything. Markets only work when producers and consumers coordinate.

If it weren’t for profit, you would not have the computer you own, the car you drive, the seat you sit in at school, the food you eat, the clothes you wear, or even your textbook. The things that we take for granted are made, not because the producers care about us, but because there is profit to be had in providing these goods to us. It is through this desire for profits that businesses make our lives better off.

This is the beauty of the market; this is what Adam Smith had in mind when he discussed the Invisible Hand. By consumers pursuing their self-interest and by businesses pursuing their self-interest, we are all better off.  There is no direct mutual concern necessary for us to make each other better off.

Now it’s Your Turn

 

Assume the market price is $200.  Fill in the rest of the chart below:

Output	Cost	Marginal Cost	Revenue	Marginal Revenue
0	$100	--------------	--------------	--------------
1	$180	$80
2	$270	$90
3	$370	$100
4	$480	$110
5	$500	$120

 

Practice Quiz

1. Production is the process of turning:
1. Outputs into inputs.
2. Inputs into outputs.
3. Revenue into costs.
4. Money into costs.

 

2. In a market, most businesses attempt to:
1. Promote positive social outcomes.
2. Improve the environment.
3. Maximize profits.
4. Pillage the consumer.

For questions 3-5, please refer to the chart below:

Output	Cost	Marginal Cost	Revenue	Marginal Revenue
0	$100	--------------	--------------	--------------
1	$150	$50
2	$210	$60
3	$280	$70
4	$360	$80
5	$450	$90

3. If the market price for a unit of output is $100, the marginal revenue of increasing output from two to three units is:
1. $450.
2. $300.
3. $210.
4. $100.

 

4. The marginal cost of increasing output from three units to four units is:
1. $50.
2. $80.
3. $360.
4. $280.

5. The revenue for producing five units is (if the market price is $100):
1. $400.
2. $500.
3. $75.
4. $50.

 

 

 

Please use the following chart for questions 6-8:

Number of Bakers	Number of Cakes Made Per Week	Marginal Product of Labor	Average Product of Labor
1	7
2	13
3	18

6. The marginal product of labor for the second employee is:
1. 7.
2. 6.
3. 13.
4. 0.

 

7. The average product of having three workers is:
1. 18.
2. 13.
3. 6.
4. 8.

8. The marginal product of labor of the third worker is:
1. 5.
2. 4.
3. 18.
4. 6.

 

9. If you are a baker, the building you are renting for 30 years is:
1. A fixed cost.
2. A variable cost.
3. An input.
4. Both A and C.

• The wages you pay your employees are:

1. A fixed cost.
2. A variable cost.
3. Charity.
4. Average cost.

Answer Key

• B
• C
• D
• B
• B
• B
• C
• A
• D
• B