Topic 4 The Cost of Production-1

Topic 4 The Cost of Production-1 - Topic 4 The Cost of...

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Topic 4 The Cost of Production
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The Firm and Its Economic Problem A firm is an institution that hires factors of production and organizes them to produce and sell goods and services. The Firm’s Goal A firm’s goal is to maximize profit. If the firm fails to maximize its profit, the firm is either eliminated or taken over by another firm that seeks to maximize profit.
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The Firm’s Constraints The firm’s profit is limited by three features of the environment: Technology constraints Information constraints Market constraints The Firm and Its Economic Problem
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Technology Constraints Technology is any method of producing a good or service. Technology advances over time. Using the available technology, the firm can produce more only if it hires more resources, which will increase its costs and limit the profit of additional output. The Firm and Its Economic Problem
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Information Constraints A firm never possesses complete information about either the present or the future. It is constrained by limited information about the quality and effort of its work force, current and future buying plans of its customers, and the plans of its competitors. The cost of coping with limited information limits profit. The Firm and Its Economic Problem
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Market Constraints The quantity each firm can sell and the price it can obtain are constrained by its customers’ willingness to pay and by the prices and marketing efforts of other firms. The resources that a firm can buy and the prices it must pay for them are limited by the willingness of people to work for and invest in the firm. The expenditures that a firm incurs to overcome these market constraints limit the profit that the firm can make. The Firm and Its Economic Problem
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Technology and Economic Efficiency Why Microsoft employs large amount of human capital, but small amount of physical capital? Why coal-mining company employs a huge amount of mining equipment (physical capital) and small amount of labor? It is because efficiency!
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Technological Efficiency Technological efficiency occurs when a firm uses the least amount inputs to produce a given quantity of output. Different combinations of inputs might be used to produce a given good, but only one of them is technologically efficient. If it is impossible to produce a given good by decreasing any one input, holding all other inputs constant, then production is technologically efficient. Economic Efficiency Economic efficiency occurs when the firm produces a given quantity of output at the least cost. The economically efficient method depends on the relative costs of capital and labor. The difference between technological and economic efficiency is that technological efficiency concerns the quantity of inputs used in production for a given quantity of output, whereas economic efficiency concerns the cost of the inputs used.
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