ECON1101 Chapter Notes - Chapter 6: Diminishing Returns, Marginal Revenue, Marginal Cost
Chapter 6
• Firm (company, business): organisation that produces goods and
services
o Labour components of firm:
▪ Workers/employees: usually paid a fixed wage or salary
and told what to do
▪ Managers: make decisions and monitor workers
▪ Owners: fund firm’s investments and bear financial risks
o Why do firms exist: (why do they not just get outside contractors)
▪ Minimize transaction costs (hire someone and when the
needs arise tell them what to do rather than → finding a
contractor, writing contract, etc.
▪ Individual contracts unwieldy with team production (team
needs to work well together)
▪ Difficult or costly to specify complete contracts
o We assume firm’s goal is to maximize profit
• Sole proprietor/ partnership: small number of owners, which manage
the firm
• Corporation: owners and managers have very little interaction
(managers have share in profits → incentive)
• Price taker: any firm that takes the market price as given; this firm
cannot affect the market price because the market is competitive
• Competitive market: a market in which no firm has the power to affect
the market price of any good
o At least seven firms competing with one another
o Individual firm demand is perfectly elastic at the market price
• Profits: total revenue – total costs (if equal → breaking even)
• Total costs: the sum of al costs incurred in producing goods and services
• Production function: a relationship that shown the quantity of output
for any amount of input
• Production: a process that transforms inputs to outputs
o Inputs production/ technology > output
o Output: Q = F (L , K)
o L= labour capital, K= capital input
o Depending on time horizon, not all inputs can be varied some may
be fixed
o Short run: some inputs are variable, all others fixed
• Marginal product of labor: the change in production due to a one- unit
increase in labour input
o Diminishing returns to labor: a situation in which the output due
to a unit increase in labor declines with increasing labor input
▪ Each worker has fewer tasks to do if the capacity of
factory/land is not increases → less additional output
o MPL = ∆Q/∆L roughly
• Variable costs: costs of production that vary with the quantity of
production
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