Production and Cost: The Supply Side in the Short Run
5.1 Profit Maximization Firms and Perfectly Competitive Markets
Profit=RevenueExpenses( Total Variable Cost)
Price takers are firms who cannot influence price on the market and sell their products
by a given price.
Profit maximizing firmfirms whos main purpose is to maximize its profit. It combines
factor of production to produce a good or service.
Intermediate inputsis an input that will be used up while producing an output( ex: paint
will be used by when house will be done)
Short run and long run are terms used to distinguish how long it takes for a firm to
change all or some aspects of production.
Production Function the technical relationship between input and output
Marginal productincrease in total output caused by increase in one unit in the variable
factor of production
A variable factor of production changes as output changes
A FIXED factor of production cannot be changed in the short run so it cannot change as
Marginal product of laborhiring one more worker
Marginal product labor inversely related to Marginal cost of production => higher
marginal product means lower marginal cost.
Law of Diminishing Marginal Returns
Beyond some point the marginal product decreases as more units of variable factor of
production are used. (works when one factor of production is fixed)
Average product is total output divided by units of variable factor of production (output
unit per unit of variable input).
5.2 Graphing the Relationships Among Total, Average and marginal Values
Studying this relationship will help us to define how the law of diminishing marginal
returns interacts with principle with increasing opportunity coast.
1 employee adds large amount of total output, the marginal product of the 2 employee
is even bigger however the marginal product of the 3d employee is lower, that is where
the law of diminishing marginal returns appear.
4 elements of the relationship between average and marginal product:
(1) maximum marginal product occurs at a lower level of output than maximum average
(2) Marginal product =average product => maximum average product
(3) if marginal product > average product => average product is increasing
(4) if marginal product average product is decreasing.
(5) marginal product=0 and shifts from positive to negative at the point of maximum
possible output Fixed costany cost hat does not change
when output changes Variable Cost any cost that changes as
Fixed factor of production is a fixed firm changes output
Marginal Revenue is the additional revenue generated by one more unit of output. Marginal Revenue Product is the additional revenue generated by one more unit of
Marginal Cost is the increase in total cost incurred marginal revenue with marginal cost,
it is applying the costbenefit principle.
Marginal Cost= Change in total wages paid/change in total output
Marginal revenue >
marginal cost => increase in profit by
providing more output
Marginal revenue more output result in decrease in profit
When the law of diminishing marginal returns applies (i.e., when at least one factor of
production is fixed), marginal cost goes up as the firm increases production.
Shut Down Case
Market price for the firm’s product is less the Average variable cost