Unit 2: Production Flashcards
Economic systems..
- 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)
Canada is primarily a market economy
largely determined by free competition amongst businesses
Governments create laws to…
- 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
The primary goal of firms is to
create profit
The role of firms is to create
goods and services that society needs
This is how firms make profits
People within firms are the ones who make the economic decisions
- What, and how much to produce
- How to do it all
Small firms:
Could be as few as one person making economic decisions
Large firms:
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
“The bottom line”
- last line of an accounting sheet, which shows either a loss or accounting profit
Accounting profit:
the excess of revenues over costs
Accounting profit tells decisions makers whether they can stay in business or not
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
Benefits of Profits For a Firm
- For producers, profits act as an incentive and a reward for the work they do and risks they take
- Profits are the producer’s least expensive source of money for expanding of improving production
- Producers use profits to evaluate how well their firm is doing
- Compare profits with those of competitors
Profits of individual product lines within a firm help determine how resources should be used - Resources shift to products in demand, thus meeting consumer needs
- High profits allow privately owned companies to pay dividends to their shareholders
Theory of the Firm
- 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.
The Theory of the Firm:
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
total profit = total revenue - total costs
total profit = total revenue - total costs
Total Revenue
Two factors:
- Price of an item
- Quantity that a firm sells of that item
total revenue = price x quantity sold
Total Costs
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
Revenue is not everything
- Higher priced product does not necessarily yield higher profits
- Higher price may reflect higher cost of production
- Higher price may discourage sales
Variable Costs:
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)
Fixed Costs:
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)
Theory of the Firm Eqn
total profit = (price x quantity sold) - (fixed + variable costs)
The short run:
period of time over which the firm’s maximum capacity becomes fixed because of the shortage of at least one resource.
The long run:
period of time when all costs become variable, and there are no fixed costs of production.
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.
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
Marginal Cost:
The additional cost for a firm of producing one more unit of its produc
Marginal Revenue:
The additional revenue gained by a firm from producing one more unit of its product.
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
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)
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.
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
Profits are maximized at a production level when:
marginal revenue = marginal costs
