Firms and Markets

• What is a firm?

  An institution that hires production factors
• What is the primary goal of a firm?

  To maximize profit
• What happens if a firm fails to maximize profit?

  It may go out of business or be taken over
• What are the five basic decisions a firm must make to maximize profit?

  1. What to produce and in what quantities
  2. How to produce
  3. How to organize and compensate managers and workers
  4. How to market and price products
  5. What to produce itself or buy from others
• What are the three constraints on a firm's profit?

  Technology, information, and market constraints
• How is profit calculated?

  Profit = total revenue minus total cost
• What are the two time frames for decisions in a firm?

  The short run and the long run
• What is fixed in the short run for most firms?

  The capital, called the firm's plant
• What can be changed in the short run?

  Labor, raw materials, and energy
• What is the definition of the short run?

  A time frame with fixed resource quantities
• What is the definition of the long run?

  A time frame where all resources can vary
• What are the assumptions of the short-run model?

  • Firms try to maximize profits
  • Output is produced from a mix of inputs
  • Firms choose their technology
  • Inputs are capital and labor
• How can a firm increase output in the short run?

  By increasing the amount of labor employed
• What are the three concepts that describe the relationship between output and labor?

  1. Total product
  2. Marginal product
  3. Average product
• What is total product?

  The total output produced in a period
• What is marginal product of labor?

  The change in total product from one more worker
• How is average product of labor calculated?

  Total product divided by quantity of labor employed
• What does the total product curve show?

  How total product changes with labor employed
• What does the total product curve separate?

  Attainable output levels from unattainable levels
• What happens to total product as more labor is hired?

  • Total product rises steeply at first
  • Then rises less steeply
  • The slope of the total product curve changes
• What is marginal product?

  The extra output from hiring one more worker
• How is marginal product measured?

  Change in output divided by change in labor input
• What does increasing marginal returns indicate?

  Marginal product exceeds the previous worker's output
• What does diminishing marginal returns indicate?

  Marginal product decreases as more labor is hired
• What causes increasing marginal returns?

  • Increased specialization
  • Division of labor
• What causes diminishing marginal returns?

  • Less access to capital
  • Less space for workers
• How is productivity measured in a firm?

  Output per person
• What is average product of labor?

  Output per person at current output level
• How should productivity of labor be measured?

  Use average product for overall productivity
• What does the production function table show?

  Outputs with different levels of inputs
• What indicates increasing returns to scale?

  Output more than doubles when inputs double
• What indicates decreasing returns to scale?

  Output does not double when inputs double
• What are the key points from the summary of the production model?

  • Firms maximize profit
  • Profit is constrained by factors
  • Focus on technology and short-run constraints
  • Total, marginal, and average product are key concepts