Chapter 7: The Production Process: The Behavior of Profit-Maximizing Firms

ECON 110 Exam 1

(1) How Much Output to Supply – Quantity of products or services a firm should offer; Influenced by market demand, production capacity, and competitive dynamics

(2) Which Production Technology to Use – Firms decide on the most efficient technology for production; Should they invest in labor-intensive methods or capitalize on advanced machinery?; This decision hinges on cost, scalability, and the nature of the product

(3) How Much of Each Input to Demand – Determining the quantity and mix of inputs–be it labor, materials, or capital; Firms must balance quality, cost, and supply considerations to maintain efficient production without overspending

What are the three decisions that all firms must make?

Profit

The difference between total revenue and total cost.

Total Revenue

The total amount that a firm takes in from the sale of its product: the price per unit times the quantity of output the firm decides to produce.

Total Cost

Total fixed costs plus total variable costs.

Economic Profit

Profit that accounts for both explicit and opportunity costs.

Explicit Costs

Direct payments made to others in the course of running a business such as wages, rent, and materials.

Opportunity Costs

The total benefits an individual, investor, or the entire business misses out when choosing one alternative over another.

Normal Rate of Return

A rate of return on capital that is just sufficient to keep owners and investors satisfied. For relatively risk-free firms, it should be nearly the same as the interest rate on risk-free government bonds.

Short Run

The period of time for which two conditions hold: The firm is operating under a fixed scale (fixed factor) of production, and firms can neither enter nor exit an industry.

Long Run

That period of time for which there are no fixed factors of production: Firms can increase or decrease the scale of operation, and new firms can enter and existing firms can exit the industry.

(1) Market price of output: potential revenues

(2) Production techniques that are available: how much input needed

(3) Input prices: costs

What are the three things a firm needs to know?

Optimal Method of Production

The production method that minimizes cost for a given level of output.

Production Technology

The quantitative relationship between inputs and outputs.

Labor-Intensive Technology

Technology that relies heavily on human labor instead of capital (machinery).

Capital-Intensive Technology

Technology that relies heavily on capital instead of human labor.

Production Function or Total Product Function

A numerical or mathematical expression of a relationship between inputs and outputs. It shows units of total product as a function of units of inputs.

Marginal Product

The additional output that can be produced by adding one more unit of a specific input, ceteris paribus.

Law of Diminishing Returns

When additional units of a variable input are added to fixed inputs, after a certain point, the marginal product of the variable input declines.

Average Product

The average amount produced by each unit of a variable factor of production.

Average product is at its maximum at the point of intersection with marginal product. Indicates the peak efficiency of input use.

When is average product at its maximum?