ECON101: Principles of Microeconomics

Unit 6: The Producer

• Upon successful completion of this unit, you will be able to:

  • analyze the behavior of the producer;
  • compare the costs of production in the short run to the costs of production in the long run;
  • compute the relationship between different cost functions; and
  • identify the production function in the short run as well as the long run.
    

• 6.1: Introduction to Production and the Firm

  Imagine a scenario where you could manufacture your iPod, iPhone, and Mac at home for the same price or even less than you can buy in a store. Would Apple still exist?

  Firms primarily exist because they organize the factors of production (labor, land, capital, and technology) to reduce the costs individual consumers would face if they tried to produce everything themselves. We can define a firm as an institution that organizes factors of production to produce output and maximize its profit (revenue minus cost).

  Once we understand that firms exist to reduce transaction costs (any costs associated with engaging in production or consumption activities) and their goal is to maximize profit, several questions arise:

  • What should be produced?
  • How should it be produced? (considering the amount of each input used)
  • How much should be produced?
  • Where should it be produced?

  We begin to answer these questions by considering the time frame. In microeconomics, the distinction between the short run and the long run is critical, especially on the production side.
  

  • Short Run vs. Long Run Production Page

    Mark as completed

    Watch this video, which explains the difference between the short run and the long run. Consider how long it takes firms to change their factors of production.
    

  • Accounting Costs vs. Economic Costs Page

    Mark as completed

    A firm's decision regarding the quantity of output to produce depends on the market structure where it operates (we learn about market structures in Unit 7) and the cost of production. The analysis of production costs takes us back to Unit 1 – we need to consider the direct costs and the opportunity costs of production, also known as implicit costs.

    Watch this video on the difference between accounting costs (direct costs) and economic costs (explicit and implicit costs). You might have to readjust your thinking about what cost means in economic analysis.
    

• 6.2: Production Decisions in the Short Run

  The long run is the time period when all costs are variable because the firm has time to change all the factors of production. In this section, we study how the firm makes profit-maximizing decisions in the long run. We start by analyzing the long-run production function to then explore the costs in the long run and the relationship between short and long-run costs.

  Think of the production function as the magical cookbook for firms' decisions. It is like having a high-tech cooking device to turn the factors of production into the optimum number of delicious chef-like dishes.
  

  • Production in the Short Run Page

    Mark as completed

    Read this text to review the factors of production introduced in Unit 1 and to learn how to obtain and interpret the production function in the short run. Understanding the production function will pave the way for grasping concepts like total and marginal product (or output). The text also introduces the critical law of diminishing marginal returns.
    

  • Total Product, Marginal Product, and Average Product Page

    Mark as completed

    The previous reading introduced several new concepts. Watch this video on total, average, and marginal products and the law of diminishing marginal returns to labor to ensure a solid understanding of these essential economic ideas and relationships.
    

  • Costs in the Short Run Page

    Mark as completed

    As you know, a firm's costs depend on the quantities of factors of production the firm uses and the cost of those factors of production. We now focus on the analysis of costs in the short run. Why do you think costs differ in the short and the long run?

    Read this text, which explores short-run costs. Make sure you can define, calculate, and graph total cost, average total cost, average variable cost, and marginal cost.
    

  • Fixed and Variable Costs Page

    Mark as completed

    Let's watch the following four videos to further clarify the new concepts introduced in the reading. We start by reviewing the concepts of fixed versus variable costs and then dive into a dynamic explanation of the cost curves. And because we understand that all those diagrams can make you dizzy, we have included a video on why it is crucial to grasp them all.
    

  • Self-Check Questions Page

    Mark as completed

    Once you complete the videos, you should be well-prepared to answer the following review questions.

    You have just completed a challenging section packed with new concepts. With the relevant information in your hands, you should be able to answer the question posed at the beginning: how many units of pizza to prepare daily if you can only change the number of workers you hire?
    

• 6.3: Production Decisions in the Long Run

  The long run is the time period when all costs are variable because the firm has time to change all the factors of production. In this section, we study how the firm makes profit-maximizing decisions in the long run. We start by analyzing the long-run production function to then explore the costs in the long run and the relationship between short and long-run costs.
  

  • Production in the Short Run and the Long Run Page

    Mark as completed

    Read this short section, which compares short-run and long-run production and introduces the long-run production function.
    

  • Costs in the Long Run Page

    Mark as completed

    You should now be able to explain why the long-run production function represents the most efficient way to produce any level of output. If the answer readily comes to your mind, you are prepared to explore the analysis of costs in the long run.

    Read this text on how to calculate the long-run total cost. Compare the long-run average cost curve with the short-run average cost curve. Make sure you can differentiate economies of scale, diseconomies of scale, and constant returns to scale. You should also be able to compare economies of scale and diminishing marginal returns.
    

  • Long Run Average Total Cost Curve Page

    Mark as completed

    Watch this video to review how we obtain and graph the long-run average total cost curve and its relation to the short-run average total cost curve.
    

  • Economies and Diseconomies of Scale Page

    Mark as completed

    To finish this unit, watch this video to review the essential economic concept of economies of scale. By the end, you should be well-prepared to address the question posed: "Why are people and economic activity concentrated in cities rather than distributed evenly across a country?"

    We started this unit by asking these questions:
    

    • What should be produced?
    • How should it be produced? (considering the amount of each input used)
    • How much should be produced?
    • Where should it be produced?

    As previously mentioned, the answers to these questions depend on several factors, including the time frame considered, the costs of the firm, and the market structure within which the firm operates. In this unit, we have delved into the first two aspects. In the upcoming unit, we explore the various market structures where a firm can conduct its business.
    

• Unit 6 Assessment

  • Unit 6 Assessment Quiz

    Receive a grade

    Take this assessment to see how well you understood this unit.

    • This assessment does not count towards your grade. It is just for practice!
    • You will see the correct answers when you submit your answers. Use this to help you study for the final exam!
    • You can take this assessment as many times as you want, whenever you want.