ECON 230 Lecture Notes - Indifference Curve, General Partnership, Perfect Competition

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Chapter 6: Firms and Production
6.1 The Ownership and Management of Firms
Private, Public and Nonprofit firms
- Private sector: Owned by individuals or other non-governmental entities and
whose owners try to earn a profit
- Public sector: Firms and organizations that are owned by governments or
government agencies
- Non-for-profit sector: Organizations that are neither government-owned nor
intended to earn profit
o Pursue social or public interest objectives
The Ownership for For-Profit Firms
- Sole proprietorship: Firms owned by a single individual who is personally liable
for the firm’s debts
- General Partnership: Businesses jointly owned and controlled by two or more
people who are personally liable for the firm’s debts
- Corporations: Owned by shareholders in proportion to the number of shares of
stock they hold
o Limited liability: the personal assets of corporate owners cannot be taken to
pa a corporation’s debts even if it goes into bankruptcy
What Owners Want
- To maximize profit
- = R C
- : Profit; R: Revenue; C: Cost
- R = pq
- p: Price; q: Quantity
- Efficient production: if the firm cannot produce its current level with less inputs
6.2 Production
- Capital service (K): Use of long-lived inputs such as land, buildings, and equipment
- Labor service (L): Hours ofwork provided by managers, skilled workers, and less-
skilled workers
- Materials (M): Natural resources and raw goods and processed products
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Production Functions
- The relationship between the quantities of inputs used and the maximum quantity
of output that can be produced, given current knowledge of technology and
organization
- q = f (L,K)
o Where q units are produced using L units of labor services and K units of
capital
o Function only shows the maximum amount of output that can be produced
from given levels of labor and capital
Time and the Variability of Inputs
- Short run: The period of time so brief that at least one factor of production cannot
be varied practically
- Fixed input: A factors that a firm cannot vary practically in the short run
- Variable input: Factor of production whose quantity the firm can change readily
during the relevant time period
- Long run: Long enough period of time that all inputs can be varied
o No fixed inputs all factors of production are variable inputs
6.3 Short-Run Production: One Variable and One Fixed Input
- In the short run, we assume capital is a fixed input and that labor is a variable input
o Increasing output by altering only labor
- Production Function
o q = f (L,K)
o q: Output; L: Workers;K: Fixed number of unites of capital
o It is the amount of output that a given amount of labor can produce holding
the quantity of other inputs fixed
- Marginal Product of Labor
o MPL = 
 

o The exact relationship between output and labor
- Average Product of Labor
o APL =
o The ratio of output to the number of workers used to produce that output
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6.4 Long-Run Production: Two Variable Inputs
- Both capital and labor are variable
- The firm can substitute one input for another while continuing to produce the same
level of output, in much the same way a consumer can maintain a given level of
utility
- Cobb-Douglas Production Function
o q = LaKb
o L: Labor (workers) per day; K: Capital services per day
Isoquants
- Curve that shows the efficient combinations of labor and capital that can produce a
single (iso) level of output (quantity)
- If the production function is q = f(L,K) then the equation for an isoquant where
output is held constant at q is
o q = f(L,K)
- Isoquants show a firm’s flexibility in producing a given level of output
o Smooth curves because the firm can use fractional units of each input
- Properties of Isoquants:
o Same properties as indifference curves except that isoquants holds quantity
constant whereas indifference curves hold utility constant
o The farther an isoquant is from the origin, the greater the level of output
o Isoquants do not cross
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