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 productionDefinition:Supply decisions focus on how we can most efficiently use our factors of productionWHAT IS THE LEAST AMOUNT OF RESOURCES THAT CAN BE USED TO PRODUCE A GOOD?Production FunctionThe relationship that shows the maximum amount of a good or service we can possibly make from different combinations of factor inputThe purpose of the production function is to tell us how much output can produce with varying amounts of factor inputs
4 Effeiciency & Capacity EfficiencyThe production function represents the MAXIMUM output we could produce with a given amount of our factors of production.CapacityLand and capital constraints place a ceiling on potential output
7 Costs of production REMEMBER: New formula: Total Cost total revenue = price X quantity soldNew formula:Total profit = total revenue – total costsThe most desirable level of output for produces is the one that maximizes profitTotal CostDefinition: 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 changesexamples: cost of factory itself, cost of equipment such as sewing machinesSHORT RUNCannot avoid fixed costs in short runFixed costs only exist in short run
9 Variable CostsDefinition: costs of production that change when the rate of output is alteredRate at which total cost rises depends solely on the variable costsAs 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)