T06 PRODUCTION AND COSTS

• Firm


  An entity concerned with the purchase and employment of resources in the production of various goods and services
• Forms of business organizations


  • Sole proprietorship
  • Partnership
  • Corporation
• Sole proprietorship


  • Easy to set up and organize
  • All profits and all costs assumed by the owner
  • Unlimited liability
• Partnership


  • Easy to organize; less legal expense and paperwork
  • Partnership is dissolved when partner dies
  • Unlimited liability
• Corporation


  • Most dominant form of business enterprise
  • Most effective for raising financial capital
  • When any of its owners dies, corporation is NOT dissolved
  • Substantial legal expense in setting up
  • Principal-agent problem may occur
• Production function


  The physical relationship between the inputs of a firm and its output of goods and services, ceteris paribus
• Inputs of a firm


  • Land
  • Labor
  • Capital (physical)
• Fixed inputs


  Inputs used at a constant quantity whatever the level of output produced
• Variable inputs


  Inputs that change in quantity depending on the level of output being produced
• Short run


  Period where some inputs are fixed
• Long run


  Period where all inputs are variable
• Total product (TP or Q)


  The total amount of output produced by the firm, measured in physical units
• Marginal product (MP)


  The change in the quantity of the output given a one unit change in the quantity of an input, holding all other inputs constant
• The principle of diminishing marginal product states that as the use of an input increases (with other inputs fixed), a point will eventually be reached at which the resulting additions to output decrease
• Average product (AP)


  The total output per unit of input used
• Stages of production


  • Stage I: AP is increasing, MP > AP
  • Stage II: AP begins to decline, MP < AP, TP reaches maximum
  • Stage III: MP < 0, AP and TP decreasing
• Opportunity cost

  The value of output sacrificed elsewhere