Boundless EconomicsPrinciples of Economics
Basic Economic Questions
Production OutputsA firm's production outputs are what it creates using its resources: goods orservices.
Learning ObjectivesIdentify how suppliers determine what and how much to supply
Key TakeawaysKey PointsThe profit -maximizing amount of output occurs when the marginal cost ofproducing another unit equals the marginal revenue received from selling thatunit.Output are the quantity of goods or services produced in a given time period, bya firm, industry or country.There are four types of market scenario that a firm may encounter when makinga production decision: economic profit, normal profit, loss-minimizing condition,and shutdown. The firm should always produce unless it encounters a shutdownscenario.
Key Termsmarginal cost: The increase in cost that accompanies a unit increase in output;the partial derivative of the cost function with respect to output. Additional costassociated with producing one more unit of output.
variable cost: A cost that changes with the change in volume of activity of anorganization.average total cost: Average cost or unit cost is equal to total cost divided by thenumber of goods produced (the output quantity, Q). It is also equal to the sumof average variable costs (total variable costs divided by Q) plus average fixedcosts (total fixed costs divided by Q).fixed costs: A cost of business which does not vary with output or sales;overheads.
Production outputs are the goods and services created in a given time period, bya firm, industry or country. These goods can either be consumed or used forfurther production. Production outputs can be anything from crops totechnological devices to accounting services. Producing these outputs incurcosts which must be considered when determining how much of a good shouldbe produced.
Determining what to produce and how much to produce can be difficult.Microeconomics assumes that firms and businesses are profit-seeking. Thismeans that above all else they will produce goods and services to the degreethat maximizes their profits. In economic theory, the profit-maximizing amountof output in occurs when the marginal cost of producing another unit equals themarginal revenue received from selling that unit. When the product's marginalcosts exceeds marginal revenue, the firm should stop production.
MCPrice
Quantity
D=AR=MR
ATC
P
Q
CA
B
Production Conditions: A firm will seek to produce such that itsmarginal cost (MC) is equal to marginal revenue (MR, which is equalto the price and demand). It is not produced based on average totalcost (ATC).
Once a firm has established what its profit-maximizing output is, the next step itmust consider is whether to produce the good given the current market price.There are several key terms to be familiar with prior to addressing this question.
Fixed costs are those expenses that remain constant regardless of the amount ofgood that is produced. For example, no matter how much of a good youproduce, you will still have to pay the same amount of rent for your factory orstorage units.Variable costs are only those expenses that are directly tied to the production ofmore units; fixed costs are not included.Opportunity costs are the cost of an opportunity forgone (and the loss of thebenefits that could be received from that opportunity); the cost equals the mostvaluable forgone alternative.
Average total cost is the all expenses incurred to produce the product, includingfixed costs and opportunity costs, divided by the number of the units of thegood produced.
There are four different types of conditions that generally describe a firm's profitas described in:
Economic Profit: The firm's average total cost is less than the price of eachadditional product at the profit-maximizing output. The economic profit is equalto the quantity output multiplied by the difference between the average totalcost and the price.Normal Profit: The average total cost equals the price at the profit-maximizingoutput. In this case, the economic profit equals zero. In this scenario, the firmshould produce of the product.Loss-minimizing condition: The firm's product price is between the average totalcost and the average variable cost. The firm should still continue to producebecause additional sales would offset a portion of fixed costs. If themanufacturer stopped production, it would sustain all the fixed costs as a loss.Shutdown: The price is below average variable cost at the profit-maximizingoutput. Production should be shutdown because every unit produced increasesloss. The revenue gained from sales of these products do not offset variable andfixed costs. If it does not produce goods, the firm suffers a loss due to fixedcosts, but it does not incur any variable costs.
Production Inputs and ProcessLabor, capital, and land are the three necessary inputs for any productionprocess.
Learning Objectives
Explain the use of capital and labor in production
Key TakeawaysKey PointsCapital, otherwise known as capital assets, are manufactured goods that are usedin production of goods or services.Cash is not included in capital in terms of a production input. Homes andpersonal automobiles are also not included in capital because these items arenot directly tied to the production of goods or services.Labor is a measure of the work done by human beings to create a manufacturedoutput.
Key Termscapital: Already-produced durable goods available for use as a factor ofproduction, such as steam shovels (equipment) and office buildings (structures).labor: The workers used to manufacture the output.input: Something fed into a process with the intention of it shaping or affectingthe outputs of that process.
The process of production generates output, otherwise referred to as good andservices. Production processes require three inputs: land, capital and labor. Landis simply the place where you produce your product, whether it is a factory or afarm, and may included capital if the output being created is a service. In mostscenarios, the inputs in the production process are primarily capital and labor.
CapitalCapital, otherwise known as capital assets, are manufactured goods that are usedin production of goods or services. Control of these assets are the primarymeans of creating wealth. Included in capital is anything that has beenmanufactured that can be used to enhance a person's ability to perform
economically useful work. For a caveman, a stick or a stone would have beenconsidered capital. For a post-industrial worker, a laptop, computer, andcellphone would be considered capital.
Girls running warping machines in Loray Mill, Gastonia, N.C. by LewisHine, 1908.: Any tool or machine that could be used to improve someone'sability to work would be included in capital.
In regards to production, it also is important to know what capital is not. Whilecapital may refer to funds invested in a business in other disciplines such asaccounting, cash is not included in capital in terms of a production input ineconomics. Homes and personal automobiles are also not included in capitalbecause these items are not directly tied to the production of goods or services.
Labor
Labor is a measure of the work done by human beings to create a manufacturedoutput. Producers demand labor because it aids in producing output which canthen be sold. In production, a worker will only be hired when the marginalrevenue s/he brings in exceeds or equals the marginal cost of hiring that worker.The cost of one worker is the wage.
The value of labor varies based on the skills and talents that the individualworker brings to that job. If the job involves designing and building a computer,an engineer's labor is more valuable than a tailor. If the job requires themanufacture of a suit, an employer would prefer the tailor. Other elements thatinfluence the perception of the value of a specific type of labor in productioninclude the amount of training necessary to execute the task and the barriers toconducting that type of work.
Production RecipientsThe process of producing and distributing a good or service is called a supplychain, and it is composed of many economic actors.
Learning ObjectivesIdentify the market actors involved in taking a product from the originalproducer to the consumer
Key TakeawaysKey PointsSupply chains vary based on industry, the resources of the manufacturer, andmarket conditions.The purpose of a supply chain is to act as an integrating function that links majorbusiness functions and processes into a cohesive business model.Typical steps in a supply chain include: extraction of raw materials; acquisition ofcomponents; production; inventory; transportation; wholesaler; and retailer.
Key Termssupply chain: A system of organizations, people, technology, activities,information and resources involved in moving a product or service from supplierto customer.
A supply chain is a system of organizations, people, activities, information andresources involved in moving a product or service from supplier to customer. Thecompany's supply chain illustrates the total process of transforming rawmaterials into a finished product, and then selling that finished product toconsumers.
Supply Chain: This represents the typical supply chain for a computer. The righthalf of the chart represents the steps it takes from producing the final product to
the consumers.The purpose of a supply chain is to act as an integrating function that links majorbusiness functions and processes into a cohesive business model. Whendesigned well, a supply chain is able to respond to shifts in demand and changesin the marketplace. Based on these shifts, the supply chain is able to alterproduction levels accordingly so that supply can meet demand so that the firm isable to maximize its profit.
Supply chains vary based on industry, the resources of the manufacturer, andmarket conditions. Some typical elements and actors in a supply chain include:
Extraction/Acquisition of Raw Materials or Components. Before theproduction of a good can be initiated, you need to have all of the necessaryelements. These elements could be unrefined raw materials that the companytransforms into components or pre-assembled parts. A firm may havesubsidiaries or divisions that obtain raw materials or it might acquire thoseelements from a third party.Production. This is the process that transforms the elements acquired from theprior step into the finished good. Economic actors involved in this step includeproduct designers, assembly-line workers, and floor management.Inventory. Once the good is completed, it is generally placed into a centralizedinventory location while decisions are made by inventory managers and a firm'ssales division.Transportation. Finished goods must be transported to stores and otherlocations where consumers can obtain the good. Depending on the type ofbusiness, goods may be transferred to smaller regional inventory depots,merchants, or directly to a consumer.Wholesaler. A wholesaler is someone who sells a good to smaller stores, who inturn sells the good to consumers.Retailer. The retailer buys the product in bulk and sells individual or smallergroups of units to the end consumer.
Differences Between Centrally Planned and Market EconomiesThe key difference between centrally planned and market economies is thedegree of individual autonomy.
Learning ObjectivesCompare the characteristics of capitalist and socialist economic systems
Key TakeawaysKey PointsA pure planned economy has one person or group who controls what isproduced; all businesses work together to produce goods and services that areplanned and distributed by the government.Planned economies have several advantages. Ideally, there is no unemployment,and needs never go unfulfilled; because the government knows how much food,medicine, and other goods is needed, it can produce enough for all.Realistically, these systems tend to suffer from large inefficiencies and are overallnot as successful as other types of economic systems.A pure market economy is one perfectly free of external control. Individuals areleft up to themselves to decide what to produce, who to work for, and how toget the things they need.Because there is no regulation ensuring equality and fairness, market economiesare burdened with unemployment, and even those with jobs can never be certainthat they will make enough to provide for all of their needs.Because they do not need to wait for word from the government beforechanging their output, companies under market economies can quickly keep upwith fluctuations in the economy, tending to be more efficient than regulatedmarkets.
Key Terms
Centrally planned economy: When the government is responsible for settingthe amount produced.autonomy: Self-government; freedom to act or function independently.market economy: An economy in which goods and services are exchanged in afree market, as opposed to a state-controlled or socialist economy; a capitalisticeconomy.
While there are many different variations of national economies, the twodominant economic coordination mechanisms are centrally planned and marketbased. Before you can analyze any national economy, you need to understandthese two opposing viewpoints on how to run an economy. The key differencebetween the two is the amount of individual autonomy within the two systems.
Centrally Planned EconomyA pure planned economy has one person or group who controls what isproduced; all businesses work together to produce goods and services that areplanned and distributed by the government. These economies are also calledcommand economies because everyone must follow specific guidelines set up bythe controlling authority. The reason behind this type of planning is to make surethat everything needed is produced and that everyone's needs are fulfilled. Sincemost peoples' needs are provided for in a centrally planned economy,compensation is primarily morally based. Most assets are owned by the state.
Planned economies have several advantages. Ideally, there is no unemploymentand needs never go unfulfilled. Because the government knows how much food,medicine, and other goods is needed, it can produce enough for all. Butachieving these outcomes depends on the group that organizes production anddistribution to accurately identify what the consumers will need, determine whatit would take to meet those goals, and anticipate all possible situations. Thismeans there are a lot of opportunities to make a mistake. Realistically, thesesystems tend to suffer from large inefficiencies and are overall not as successful
as other types of economic systems.
V.I. Lenin: The Soviet Union, asestablished by V.I. Lenin, is anexample of a country that tried toestablish a pure centrally plannedeconomy.
Market Based EconomyA pure market economy, or capitalist system, is one perfectly free from externalcontrol. Individuals may decide what to produce, who to work for, and how toget the things they need. They are compensated with material goods for theirwork, and most assets are privately owned. This type of economy, though it maybe chaotic at times, allows people to change along with the shifting marketconditions to maximize their profits. Although they avoid many of theinadequacies of planned economies, market economies are not free of their own
problems and downfalls. Perhaps the greatest problem is that business firms mayrefuse to produce goods that unprofitable for them. For instance, in 2000 therewas a shortage of tetanus vaccine in the United States. Because it was expensiveto make, most companies were unwilling to start production themselves, leavingonly one firm struggling to keep up with demand. In a planned economy, thisshortage would not happen because the government would boost production ofthe vaccine if it were needed.
Because there is no regulation to ensure equality and fairness, market economiesmay be burdened with unemployment and even those with jobs can never becertain that they will make enough to provide for all of their needs. Despite theseand other problems, market economies come with many advantages, chiefamong which is speed. Because they do not need to wait for word from thegovernment before changing their output, companies under market economiescan quickly keep up with fluctuations in the economy, tending to be moreefficient than regulated markets. Also, individuals have more freedom andopportunities to do the jobs they want and to profit by them.
Mixed EconomiesA mixed economy is a system that embraces elements of centrally planned andfree market systems.
Learning ObjectivesExplain the characteristics of a mixed economy
Key TakeawaysKey PointsMost of the means of production in a mixed economy are privately owned in amixed economy.The government strongly influences the economy through direct intervention ina mixed economy, such as through subsidies and regulation of the markets.
Most government intervention in mixed economy is limited to minimizing thenegative consequences of economic events, such as unemployment inrecessions, to promote social welfare.
Key Termsmixed economy: A system in which both the state and private sector direct theeconomy, reflecting characteristics of both market economies and plannedeconomies.monopoly: A market where one company is the sole supplier.
A mixed economy is a system that embraces elements of centrally planned andfree market systems. While there is no single definition of a mixed economy, itgenerally involves a degree of economic freedom mixed with governmentregulation of markets. Most modern economies are mixed, including the UnitedStates and Cuba. Countries hope that by embracing elements of both systemsthey can gain the benefits of both while minimizing the systems disadvantages.
In general, most of the means of production in a mixed economy are privatelyowned. There are some exceptions to this general rule, such as some hospitalsand businesses. The mostly private ownership of all means of production allowsthe market to quickly respond to changing circumstances and economic factors.As a result, the market is generally the dominant form of economic coordination.However, to mitigate the negative influence that a pure market economy has onfairness and distribution, the government strongly influences the economythrough direct intervention in a mixed economy. Different ways a governmentdirectly intervenes in an economy include:
granting a business a monopoly,granting a subsidy to a sector,creating and enforcing regulation,
direct participation in the market, orproviding money and other resources segments of its populations, such asthrough a welfare program.
Most government intervention in mixed economy is limited to minimizing thenegative consequences of economic events, such as unemployment inrecessions, to promote social welfare.
While mixed economies vary based on their degree of government intervention,some elements are consistent. Generally, individuals in mixed economies are ableto:
participate in managerial decisions,travel,buy and sell items privately,hire and fire employees,organize organizations,communicate, andprotest peacefully.
However, the government in mixed economies generally subsidizes publicgoods, such as roads and libraries, and provide welfare services such as socialsecurity. These governments also regulate labor and protect intellectualproperty.
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