BAUTISTA, Ghislaine Faye M.

ELE-EIT (10:00-11:30)
Economics, Investments, and Taxation Ms. Eloisa Dela Cruz

PRODUCTION THEORY outputs by profit-maximizing

business firms,
Firms:
Symbol for the definition of
o purchase inputs to produce
production
and sell outputs.
Inputs ~> Process ~> Outputs
o They demand factors of Raw Materials ~> Transform ~> Goods and Services
production in input markets
and supply goods and The Behavior of Profit-Maximizing
services in output markets. Firms
o Part of microeconomics that o This phrase means that all
supply the outputs i.e. goods firms, whether competitive or
and services. not, demand inputs, engage in
Two components of Microeconomics production, and produce
o Households outputs.
o Firms o All firms have an incentive to
Learning consumer behavior is maximize profits, and thus to
important because through that, minimize costs.
companies are able to satisfy their Firms
customers. o An organization that comes
Suburraj Ramasamy, the author of into being when a person or a
Total Quality Management, stated group of people decides to
that the most successful companies produce a good or service to
are those who satisfy their meet a perceived demand.
customers, because satisfied o Firms engage in production,
customers bring in more customers that is, they transform inputs
and pay no matter how high the price into outputs, because they
is. can sell their products for
Production theory more than it costs to produce
o Analyzes the behavior of them.
firms, the producing part of Companies can be classified into 3
the economy, and which take types of firms according to operation
charge of the production of 1. Service firm – Is an
goods that the consumers organization whose primary
demand. business is to deliver services
Production is the process by which 2. Manufacturing Firm - is any
inputs are combined, transformed, business that uses
and turned into outputs. components, parts or raw
Also, production is the process by materials to make a finished
which inputs are combined, good.
transformed, and turned into 3. A Merchandising Firm -is a
company  that buys goods
BAUTISTA, Ghislaine Faye M. ELE-EIT (10:00-11:30)
Economics, Investments, and Taxation Ms. Eloisa Dela Cruz

and then resells them, o accounting costs

generally for a higher price Economic cost
than they were purchased, for o Include the opportunity cost
a profit. of every input.
All companies are established to earn o These opportunity costs are
PROFITS, to prolong their often referred to as implicit
existence. costs.
And when asked what is the reason Economic Profit
why a firm is established, the answer o total revenue – (total
is, to make MAXIMUM PROFITS. economic costs + accounting
Profit = Selling Price – Cost Price costs)
The Behavior of Profit-Maximizing There are two types of profits
Firms o Accounting profits
1. How much output to supply o Economic profits
2. Which production technology
Profits
to use
o General Formula: Selling
3. How much of each input to
Price – Cost Price
demand
o In Economics, there are 2
A profit-maximizing firm chooses
cost prices:
the technology that minimizes its
 Accounting Costs
costs for a given level of output.
 Explicit Costs
(Seen)
Computation of Profits in Economics  Out-of-
pockets costs
o Profit= Total Revenue- Total  Economic Costs
Cost  Implicit Costs
o Total Revenue= selling price (Hidden)
x quantity  Opportunity
Total Cost (Total Economic Cost) Cost
refers to the total: Whenever resources are used to
o out-of pocket costs which invest in a business, there is an
refer to costs as an opportunity cost (opportunity lost).
accountant would calculate Costs are computed by totaling the
profit. raw materials needed to transform
o opportunity cost of all factors product:
of production o Land- the place where the
Out-of pocket costs are sometimes company does its business
referred to as: transactions or the factory
o explicit costs location where it
BAUTISTA, Ghislaine Faye M. ELE-EIT (10:00-11:30)
Economics, Investments, and Taxation Ms. Eloisa Dela Cruz

manufactures its products or Short-run refers to the period of

RENTAL COSTS time for which two conditions hold:
o Labor- the employees that o The firm is operating under a
work together to get the fixed scale (fixed factor) of
outputs (goods and services) production,
done or SALARY OR o and firms can neither enter
WAGE COSTS. nor exit an industry
o Capital- the funds used to Long-run refers to that period of
finance the business, the big time for which
machinery used to o there are no fixed factors of
manufacture the goods and production: Firms can
services or INTEREST increase or decrease the scale
COSTS. of operation, and
The most important hidden cost that o new firms can enter and
is included in economic cost is the existing firms can exit the
opportunity cost of capital. industry
Rate of Return is the annual flow of In the language of economics, a firm
net income generated by an needs to know three things:
investment expressed as a percentage o The market price of output
of the total investment also known as o The techniques of production
the Yield of the Investment. that are available
Normal Rate of Return refers to a o The prices of inputs
rate of return on capital that is just That firms interact in two time zones
sufficient to keep owners and namely:
investors satisfied o Short Run Time Dimension
o When a firm earns a
 1 to 6 months
POSITIVE level of profit, it  Describes that period
is earning more than is of time for which two
sufficient to retain the interest conditions hold:
of investors.
 The firm is
o When a firm suffers a
operating
NEGATIVE level of profit under a fixed
—that is, when it incurs a scale (fixed
loss—it is earning at a rate factor) of
below that is required to keep production,
investors happy.
 and firms can
SHORT-RUN versus LONG-RUN neither enter
DECISIONS nor exit an
industry
BAUTISTA, Ghislaine Faye M. ELE-EIT (10:00-11:30)
Economics, Investments, and Taxation Ms. Eloisa Dela Cruz

o Long Run Time Dimension o 1st Line Managers- work in

 5 to 10 years the Short Run Time
 Describes that period Dimension
of time for which Managers want to increase the
 there are no profits by increasing sales and
fixed factors decreasing total cost
of production: o How do you increase sales –
Firms can by increasing the price or the
increase or quantity
decrease the o How do you decrease cost –
scale of by decreasing
operation, and  the price or quantity
 New firms can of land
enter and  price or quantity of
existing firms labor
can exit the  price or quantity of
industry capital
In the Hierarchy of Management , Production of Technology- the
there are 3 levels in the Vertical quantitative relationship between
Hierarchy of Management inputs and outputs.
o Top Management o labor-intensive technology-
 CEO, President, OIC, technology that relies heavily
Vice Presidents on human labor of capital.
o Middle Management which o capital-intensive
refers to all managers in technology- technology that
between the Top Managers relies heavily on capital
and the First Line Managers instead of human labor.
o First Line Managers which Things to consider when choosing
means the first level of labor or capital intensive technology
managers handling the staff. o The price of the technology
 Supervisor , Chief and the price of labor
These 3 level of managers perform o The speed it will take to
their tasks in the two time zones finish the job
o Top management- work in o The availability and prices of
the Long Run Time inputs needed to run the
Dimension machinery or not to use any
o Middle Managers- work in machinery at all.
the Short Run Time Optimal method of production- the
Dimension production method that minimizes
the cost.
BAUTISTA, Ghislaine Faye M. ELE-EIT (10:00-11:30)
Economics, Investments, and Taxation Ms. Eloisa Dela Cruz

productivity of labor. Because

capital—buildings, machines, and so
on—is of no use without people to
operate it, we say that capital and
labor are.
CAPITAL enhances the productivity
of LABOR.
To choose a production technique,
Marginal product- The additional
the firm must look to input markets
output that can be produced by
to learn the current market prices of
adding one more unit of a specific
labor and capital i.e. wage rate (PL),
input, ceteris paribus.
cost per hour of capital (PK)?
Law of diminishing returns
o When additional units of a
variable input are added to
fixed inputs, after a certain
point, the marginal product of
the variable input declines.
o Begin to show up when more
and more units of a variable
input are added to a fixed
input, such as the scale of the
plant.
Law of Diminishing Product- When
additional units of variable __ no. of
employees are added to fixed
inputs___ the grill – a capital
intensive technology, after a certain
point (2 employees) , the marginal
product of the variable input (no of
employees )decline.
Average product- The average
amount produced by each unit of a
variable factor of production.
Most Economists know that the
intersection of the Total Average
Product and the Marginal Product
Curve is the optimum number of
units of labor.
Complementary Inputs- In general,
additional capital increases the