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Supply Decisions.

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Presentation on theme: "Supply Decisions."— Presentation transcript:

1 Supply Decisions

2 Fundamental Questions
What limits a firm’s ability to produce? What costs are incurred in producing a good? How do costs affect supply decisions?

3 Capacity Constraints: The Production Function
Factors of production Definition: Supply decisions focus on how we can most efficiently use our factors of production WHAT IS THE LEAST AMOUNT OF RESOURCES THAT CAN BE USED TO PRODUCE A GOOD? Production Function The relationship that shows the maximum amount of a good or service we can possibly make from different combinations of factor input The purpose of the production function is to tell us how much output can produce with varying amounts of factor inputs

4 Effeiciency & Capacity
Efficiency The production function represents the MAXIMUM output we could produce with a given amount of our factors of production. Capacity Land and capital constraints place a ceiling on potential output

5 Marginal Physical Product

6 Law of diminishing returns

7 Costs of production REMEMBER: New formula: Total Cost
total revenue = price X quantity sold New formula: Total profit = total revenue – total costs The most desirable level of output for produces is the one that maximizes profit Total Cost Definition: the market value of all resources used to produce a good or service

8 Fixed Costs Definition of Fixed Costs SHORT RUN
Costs of production that do not change when the rate of output changes examples: cost of factory itself, cost of equipment such as sewing machines SHORT RUN Cannot avoid fixed costs in short run Fixed costs only exist in short run

9 Variable Costs Definition: costs of production that change when the rate of output is altered Rate at which total cost rises depends solely on the variable costs As long as output level increases, variable costs will cause total costs to increase

10 What costs do we considered in our production decisions
To understand what level of production will enable them to maximize profit, producers need to know two distinct measurements: Average Total Cost (ATC) Marginal Cost (MC)

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