Chapter 7 Summary 1 Firms vary in size internal organization but they all take inputs transform them into outputs through a process called production 2 In perfect competition NO single firm has any control over prices This follows from two consumptions 1 Perfectly competitive industries are composed of many firms each small relative to 2 Each firm in a perfectly competitive industry produces homogeneous products the size of the industry 3 The demand curve facing a competitive firm is perfectly elastic If a single firm P above the market price it will sell nothing B c is can sell all it produces at the market price a firm has no incentive to reduce price THE BEHAVIOR OF PROFIT MAXIMIZING FIRMS p 148 4 Profit maximizing firms in all industries must make 3 choices 1 how much output to supply 2 how to produce that output 3 how much of each input to demand 5 Profit TR TC total revenue total costs TC includes 1 out of pocket costs explicit costs or accounting costs 2 the opportunity cost of each factor of production including normal rate of return on capital implicit costs 6 A normal rate of return on capital is included in TC b c tying up resources in a firm s capital stock has an opportunity cost If you start a business or buy a share of stock in a corporation you do so b c you expect to make a normal rate of return Investors will not invest their money in a business unless they expect to make a normal rate of return 7 A positive level occurs when a firm is earning an above normal rate of return of capital 8 In the short run 1 a FIXED scale or FIXED factor of production 2 NO entry to or exit from the industry In the long run 1 firms CAN CHOOSE any scale of production techniques that are available NO FIXED SCALE OR FACTOR OF PRODUCTION 2 firms CAN enter leave the industry 9 To make decisions firms need to know 3 things 1 market price of their output 2 production techniques that are available 3 prices of inputs THE PRODUCTION PROCESS p 152 10 The relationship between inputs outputs the production technology expressed numerically or mathematically is called a production function or total product function 11 The MP marginal product of a variable input is the additional output that an added unit of that input will produce if all other inputs are held constant EX TOTAL PRODUCT 0 10 25 35 10 10 0 15 25 10 10 35 25 MP marginal product NOTICE THAT YOU ARE SUBTRACTING THE SECOND TOTAL PRODUCT FROM THE ONE ABOVE IT TO GET THE MP marginal product this example is in a condensed form of a chart refer to p 153 in text book to review whole chart According to the law of diminishing marginal returns when an additional units of a variable input are added to fixed inputs after a certain point the MP of a variable input will decline EX In the chart above MP declines after 25 TOTAL PRODUCT because the more people you have working in a confined area less work is actually being produced 12 Average product is the average amount of product produced by each unit of a variable factor of production If MP is above average product the average product if the MP is below average product the average product CALCULATION Average product TOTAL PRODUCT UNITS OF LABOR EX LABOR UNITS 0 1 2 3 TOTAL PRODUCT 0 10 25 35 AVERAGE PRODUCT 0 0 10 0 10 1 12 5 25 2 11 7 35 3 NOTICE THAT YOU ARE DIVIDING TOTAL PRODUCT BY LABOR UNITS TO GET THE AVERAGE PRODUCT this example is in a condense form of a chart refer to p 153 in text book to review whole chart 13 Capital K labor L are at the same time complimentary substitute inputs Capital enhances the productivity of labor but it can also be substituted for labor CHOICE OF TECHNOLOGY p 156 14 One of the key decisions that all firms must make is which technology to use Profit maximizing firms will choose the combo of inputs that minimizes costs of producing any given level of output therefore maximizes profits