Theory of the Firm.pdf - Lecture 8 Theory of The Firm(I...

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Lecture 8 Theory of The Firm (I) Production and Cost (Short-Run)
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The Firm A firm is an institution that hires factors of production and organizes them to produce and sell goods and services. A firm’s goal is to maximize profit. If the firm fails to maximize profits it is either eliminated or bought out by other firms seeking to maximize profit.
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The Five Basic Decisions To maximize profit, a firm must make five basic decisions: 1) What goods and services to produce and in what quantities? 2) How to produce which production technology to use?
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The Five Basic Decisions 3) How to organize and compensate its managers and workers? 4) How to market and price its products? 5) What to produce itself and what to buy from other firms?
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The Firm and Its Constraints The five basic decisions of a firm are limited by the constraints it faces. There are three constraints a firm faces: Technology Information Market
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Technology Constraints Technology is any method of producing a good or service. Technology advances over time. If the firm is using the available technology, it can produce more only if it hires more resources, which will increase its costs and limit the profit of additional output Hence, technology can be a constraint
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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. As such, the cost of coping with limited information limits/constrains the profit.
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Market Constraints What a 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 a firm incurs to overcome these market constraints will limit the profit the firm can make.
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Decision Time Frames The firm makes many decisions to achieve its main objective: profit maximization . Some decisions are irreversible (or very costly to reverse) Other decisions are easily reversed and are less critical to the survival of the firm, but still influence profit
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Decision Time Frames All decisions can be placed in two time frames: The short run The long run
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Decision Time Frames - The Short Run The short run is a time frame in which the quantity of one or more resources is fixed (at least one factor is fixed) For most firms, the capital is fixed in the short run. Other resources used by the firm (such as labour, raw materials, and energy) can be changed in the short run.
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  • Fall '15
  • professor
  • Marginal product, Economics of production

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