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Unit 4_Theory of Production

Unit 4_Theory of Production - UNIT 4 THEORY OF PRODUCTION...

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UNIT 4: THEORY OF PRODUCTION Firms as Agents of Production The firm can be defined as the unit that takes decisions with respect to the production and sale of goods and services. This concept includes all kinds of business organizations, from the single proprietorship or sole trader to the corporation. It also covers the entire variety of business sizes and methods of financing, from taking small loans from the bank to thousands of shareholders and customers. Goals of the Firm The neoclassical theory of the firm makes two key assumptions: 1. Firms are profit maximizers. 2. Each firm can be regarded as a single, consistent decision-taking unit. The desire to maximize profits is assumed to motivate all decisions taken within a firm, and such decisions are assumed to be unaffected by the peculiarities of the persons taking the decisions and by the organizational structure in which they work. Using these assumptions, economists can predict the behaviour of firms. To do this, they first study the choices open to the firm, establishing the effect that each choice would have on the firm’s profits. They then predict that the firm will select the alternative that will produce the largest profits. Production In order to produce the goods and services that it sells, each firm needs inputs. Hundreds of inputs may enter into the production of any specific output. Some inputs are called intermediate goods and services; that is, they are produced by firms for use in the production of final goods and services by other firms. These intermediate goods and services appear as inputs only because the stages of production for the final product are divided among different firms. If these intermediate products are traced back to their sources, all production can be accounted for by the services of the three kinds of input. These inputs, also known as factors of production , are: 1. Labour – the physical and mental efforts provided by people. 2. Capital – factories, machines and other man-made aids to production. 3. Land – the gifts of nature, such as soil, minerals and other raw materials. Production Function The production function relates inputs to outputs. It expresses the technical relationship between a set of inputs that a firm uses and the output of a good or service that it produces. You can therefore think of a production function like a recipe for sweetbread; it tells you the quantities of each ingredient, how to combine and cook, and how many loaves you will produce. When using this function, it is important to remember that production is a flow, that is, it tells us how many units are produced per period of time. For example, when we say that production rises from 100 to 101 units; this does not mean 100 units are produced this month and 101 units in the following month. Instead, we mean that the rate of production has risen from 100 units each month to 101 units each month.
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