PMIC – Economics Ch 9
Ch 9 – Background to supply: production and
cost
9.1 Introduction
GOAL OF THE FIRM
We assume that all firms seek to maximise profits, we assume that firms act rationally,
consistently and selfishly. These assumptions coincide with the notion of economic man
(homo economicus).
1. Some firms attempt to dominate the market by maximising their sales or
market share, even if it would involve reducing their profits. Their ultimate aim is
to dominate the market to such a extent that they feel stable and secure.
2. Most large firms are not “owner-managed”, they are managed by the managers.
Owners want to maximise their profits and managers want to expand the
business (their profit increases as the business grows).
Profit is an important objective of any privately owned firm. If a firm is not profitable, it
cannot continue to exist. Firms are sometimes defined as profit-seeking business
enterprises.
Principle-agent problem = separation of ownership and control of firms is an example
of this.
- Problem is the agent knows more about the situation than the principle. =
asymmetric information between the agents and the principals.
- Result – agent may not act in principals best interest and may get away with it.
- Senior managers are the agents of the directors. (G is the agent of J)
PROFIT, REVENUE AND COST: BRIEF INTRO
Profit = surplus of revenue over cost.
Total revenue (TR) – total value of sales and is equal to the price (P) of its product
multiplied by the quantity sold (Q).
TR=P x Q
Average revenue (AR) = TR divided by quantity sold (Q).
PQ
AR=
Q
Marginal revenue (MR) = additional revenue earned by selling an additional unit of the
product.
∆ TR
MR=
∆Q
Revenue structure of a firm is determined by the type of market in which it operates.
1
, PMIC – Economics Ch 9
- Some are price takers – they accept the price determined in the market and
cannot set their own price
- Some are price makers – decide at what prices they want to sell their products.
SHORT RUN AND LONG RUN IN PRODUCTION AND COST THEORY
Short run = period during which as least one of the inputs is fixed.
- Example: firm has a factory in which certain machinery has been installed and
which can only its inputs of labour, raw materials.
Long run – all the inputs are variable
- Example: period that is long enough for the firm to decide whether or not to open
another factory or install additional machines.
Difference between the short run and the long run in production and cost theory depends
on the variability of the inputs and NOT on calendar time.
9.2 Basic cost and profit concepts
COST
Opportunity cost = the value of the next best opportunity which has been given up
when a decision has been made.
Difference between accounting costs and economic costs can be explained by
distinguishing between explicit costs and implicit costs. Accountants tend to consider
explicit costs only.
- Explicit costs = monetary payments for the factors of production (including all
implicit costs).
- Implicit costs = Those opportunity costs that are not reflected in actual
payments.
Normal profit = forms part of the firm’s cost of production.
TC Total Cost = cost of producing a certain quantity of the firms product.
AC Average Cost = TC divided by the quantity of the product produced.
MC Marginal Cost = addition to total cost (∆TC) required to produce an additional unit
of the product (∆Q).
Economic costs = value of all resources used in production. (owners time and financial
resources)
Imputed costs = values that are assigned to the owner’s time and money employed in
the firm.
- Imputed costs have to be estimated to arrive at the true opportunity or resource
costs of production.
2
Ch 9 – Background to supply: production and
cost
9.1 Introduction
GOAL OF THE FIRM
We assume that all firms seek to maximise profits, we assume that firms act rationally,
consistently and selfishly. These assumptions coincide with the notion of economic man
(homo economicus).
1. Some firms attempt to dominate the market by maximising their sales or
market share, even if it would involve reducing their profits. Their ultimate aim is
to dominate the market to such a extent that they feel stable and secure.
2. Most large firms are not “owner-managed”, they are managed by the managers.
Owners want to maximise their profits and managers want to expand the
business (their profit increases as the business grows).
Profit is an important objective of any privately owned firm. If a firm is not profitable, it
cannot continue to exist. Firms are sometimes defined as profit-seeking business
enterprises.
Principle-agent problem = separation of ownership and control of firms is an example
of this.
- Problem is the agent knows more about the situation than the principle. =
asymmetric information between the agents and the principals.
- Result – agent may not act in principals best interest and may get away with it.
- Senior managers are the agents of the directors. (G is the agent of J)
PROFIT, REVENUE AND COST: BRIEF INTRO
Profit = surplus of revenue over cost.
Total revenue (TR) – total value of sales and is equal to the price (P) of its product
multiplied by the quantity sold (Q).
TR=P x Q
Average revenue (AR) = TR divided by quantity sold (Q).
PQ
AR=
Q
Marginal revenue (MR) = additional revenue earned by selling an additional unit of the
product.
∆ TR
MR=
∆Q
Revenue structure of a firm is determined by the type of market in which it operates.
1
, PMIC – Economics Ch 9
- Some are price takers – they accept the price determined in the market and
cannot set their own price
- Some are price makers – decide at what prices they want to sell their products.
SHORT RUN AND LONG RUN IN PRODUCTION AND COST THEORY
Short run = period during which as least one of the inputs is fixed.
- Example: firm has a factory in which certain machinery has been installed and
which can only its inputs of labour, raw materials.
Long run – all the inputs are variable
- Example: period that is long enough for the firm to decide whether or not to open
another factory or install additional machines.
Difference between the short run and the long run in production and cost theory depends
on the variability of the inputs and NOT on calendar time.
9.2 Basic cost and profit concepts
COST
Opportunity cost = the value of the next best opportunity which has been given up
when a decision has been made.
Difference between accounting costs and economic costs can be explained by
distinguishing between explicit costs and implicit costs. Accountants tend to consider
explicit costs only.
- Explicit costs = monetary payments for the factors of production (including all
implicit costs).
- Implicit costs = Those opportunity costs that are not reflected in actual
payments.
Normal profit = forms part of the firm’s cost of production.
TC Total Cost = cost of producing a certain quantity of the firms product.
AC Average Cost = TC divided by the quantity of the product produced.
MC Marginal Cost = addition to total cost (∆TC) required to produce an additional unit
of the product (∆Q).
Economic costs = value of all resources used in production. (owners time and financial
resources)
Imputed costs = values that are assigned to the owner’s time and money employed in
the firm.
- Imputed costs have to be estimated to arrive at the true opportunity or resource
costs of production.
2
