Unit 2: Production

Question 1

Economic systems..

Answer 1

• The function of any economic system is to provide goods and services to satisfy wants and needs
• Three basic questions that economic systems must answer:
  What to produce?
  How to produce?
  For whom to produce?
  Command economy → determined by central authority
  Traditional economy → determined by the family
  Market economy → determined by the market (supply and demand)

Question 2

Canada is primarily a market economy

Answer 2

largely determined by free competition amongst businesses

Question 3

Governments create laws to…

Answer 3

• define, limit, and protect the process of producing
  Individuals within firms have been given the power to make production decisions
• Private firms largely determine how our scarce economic resources will be developed and used to meet the needs of citizens and residents

Question 4

The primary goal of firms is to

Answer 4

create profit

Question 5

The role of firms is to create

Answer 5

goods and services that society needs
This is how firms make profits

Question 6

People within firms are the ones who make the economic decisions

Answer 6

• What, and how much to produce
• How to do it all

Question 7

Small firms:

Answer 7

Could be as few as one person making economic decisions

Question 8

Large firms:

Answer 8

decision-making delegated to a small group of executive managers with specialized training and experience
- Division of labour, leading to better decisions and greater productivity

Question 9

“The bottom line”

Answer 9

• last line of an accounting sheet, which shows either a loss or accounting profit

Question 10

Accounting profit:

Answer 10

the excess of revenues over costs

Question 11

Accounting profit tells decisions makers whether they can stay in business or not

Answer 11

Most firms attempt to maximize profit
All firms must at least break even (profits = costs)
Failure to cover costs of production will cause the firm to go bankrupt

Question 12

Benefits of Profits For a Firm

Answer 12

1. For producers, profits act as an incentive and a reward for the work they do and risks they take
2. Profits are the producer’s least expensive source of money for expanding of improving production
3. Producers use profits to evaluate how well their firm is doing
4. Compare profits with those of competitors
   Profits of individual product lines within a firm help determine how resources should be used
5. Resources shift to products in demand, thus meeting consumer needs
6. High profits allow privately owned companies to pay dividends to their shareholders

Question 13

Theory of the Firm

Answer 13

• Is an analysis of the relationship between profits, revenues, and costs
  Total costs: The total of a firm’s fixed and variable costs, which includes all the purchases made by a firm for productive resources to produce a good or service.
  Total revenue: The price of a product multiplied by the quantity sold of a product.
  Profits: The excess of a firm’s revenues over its cost.

Question 14

The Theory of the Firm:

Answer 14

the economic relationship between total profit, revenues, and costs.
- It assumes that producers are all profit maximizers
Self-interest leads them to increase their revenues and decrease their costs in order to increase their profits

Question 15

total profit = total revenue - total costs

Answer 15

total profit = total revenue - total costs

Question 16

Total Revenue

Answer 16

Two factors:
- Price of an item
- Quantity that a firm sells of that item
total revenue = price x quantity sold

Question 17

Total Costs

Answer 17

The money a firm spends to purchase the productive resources it needs to produce its good or service
Includes all payments a firm must make to its suppliers, employees, landlords, bankers, and so on

Question 18

Revenue is not everything

Answer 18

• Higher priced product does not necessarily yield higher profits
• Higher price may reflect higher cost of production
• Higher price may discourage sales

Question 18

Variable Costs:

Answer 18

Costs that change or vary with the level of production/output.
These costs tend to rise as production rises
Often targets for “emergency cutbacks”
(Ex: labour, raw materials)

Question 18

Fixed Costs:

Answer 18

Costs that remain the same at all levels of production/output and must be paid whether the firm produces or not.
- Difficult to adjust in the short term
- Often referred to as overhead costs
(Ex: rent, property taxes, insurance premiums, and interests on loans)

Question 19

Theory of the Firm Eqn

Answer 19

total profit = (price x quantity sold) - (fixed + variable costs)

Question 20

The short run:

Answer 20

period of time over which the firm’s maximum capacity becomes fixed because of the shortage of at least one resource.

Question 21

The long run:

Answer 21

period of time when all costs become variable, and there are no fixed costs of production.

Question 22

A printing company gets a new contract that requires them to expand production immediately. The new job is so big that the printing company has to build an addition to its factory to handle it. This change can not be accomplished quickly, so the company is unable to accept the order.

Answer 22

The printing company’s ability to produce is limited, or fixed, by the size of its factory
The length of the company’s short run is defined by the length of time it would need to build an extension to its factory so that production can increase
Once the printing company builds the extension, it would be in its long run, when all costs are variable

Question 23

Marginal Cost:

Answer 23

The additional cost for a firm of producing one more unit of its produc

Question 24

Marginal Revenue:

Answer 24

The additional revenue gained by a firm from producing one more unit of its product.

Question 25

If a firm wishes to maximize its profit, it should always produce up to the point at which there is no added benefit (profit) from producing more

Answer 25

It should keep producing to the point at which the marginal cost (additional cost) of producing one more unit equals the marginal revenue (additional revenue)

Question 26

A dairy farm specializes in goat cheese. The dairy farm is located near a dozen goat farmers, which regularly supply it with the goat’s milk it requires to gain cheese.

Answer 26

Should the dairy farm decide to increase production, it would have to transport the additional milk from another area, requiring a sharp increase in transportation costs.
If the additional revenue to be had from producing more goat cheese does not exceed the additional costs, the dairy farm has no incentive to produce more

Question 27

Profits are maximized at a production level when:

Answer 27

marginal revenue = marginal costs