THE

PRODUCTION
THEORY
SELF–PACED LESSON-MICROECONOMICS

ELOISA DELA CRUZ

THE BEHAVIOR OF PROFIT-MAXIMIZING FIRMS
We now turn to the other side of the
system and examine the behavior of
firms.

Firms purchase inputs to produce and

sell outputs

They demand factors of production in input

markets and supply goods
and services in output markets.

We look inside the firm at the

production process that transforms
inputs into outputs
 CLASS
• The most important thing for you to know of
microeconomics, when it comes to the Production Theory is
- you are still in micro , thus learning the rudiments .
• Two of the rudiments is the micro
model (See the diagram ) and the
two components of micro:
1. households
2 firms

Eloisa Dela Cruz

 CLASS
• The firm is that part of microeconomics that supplies the outputs:

1. Goods

2. Services

After learning how consumers behave (why do we need to know) so that in the future ,
when we have our companies we will discern how to satisfy our customers.

Why do we need to satisfy our customers? - because as one of the authors (Suburraj
Ramasamy) of Management once said in his book, Total Quality Management

the most successful companies are those who satisfy their customers, because satisfied
customers bring in more customers and pay no

matter how high the price is.

Eloisa Dela Cruz

 CLASS
In this topic , the Production Theory , we analyze the behavior of
firms , which are the producing part of the economy. They take
charge of PRODUCTION of the outputs supplied, that the consumers
demand.
• Production is the process by which inputs are combined,
transformed, and turned into outputs.
inputs process outputs

raw materials transform goods and services

Symbol for the definition of production

Eloisa Dela Cruz
THE BEHAVIOR OF PROFIT-MAXIMIZING FIRMS

In the previous lesson we studied the

Behavior of Consumers , this time we
study the behavior of Firms.

“THE OF BEHAVIOR OF PROFIT–

MAXIMIZING FIRMS.”

What does this phrase mean ?

 THE BEHAVIOR OF PROFIT-MAXIMIZING FIRMS

This phrase means that all firms, whether competitive or not,

demand inputs, engage in production, and produce outputs.

All firms have an incentive to maximize profits

and thus to minimize costs.

Central to our analysis is production,

PRODUCTION is the process by which inputs are combined,

transformed, and turned into outputs by profit-maximizing
business firms,
 THE BEHAVIOR OF PROFIT-MAXIMIZING FIRMS

firm -
An organization that comes into being when a person or a
group of people decides to produce a good or service to meet
a perceived demand.

Firms engage in production—that is, they transform

inputs into outputs—

BECAUSE THEY CAN SELL THEIR PRODUCTS FOR MORE

THAN IT COSTS TO PRODUCE THEM.
 CLASS

Companies can be classified into 3 types of firms according

to operation
1. Service firm – Is an organization whose primary business
is to deliver services
2. Manufacturing Firm - is any business that uses
components, parts or raw materials to make a finished
good.
3. A Merchandising Firm -is a company that buys goods
and then resells them, generally for a higher price than
they were purchased, for a profit.

Eloisa Dela Cruz

CLASS

Selling Price - cost price = Profit

Benta - puhunan = tubo
All companies are established to earn Profits,
to prolong their existence. And when asked what is the reason why a
firm is established , the answer is, to make
MAXIMUM PROFITS
This question was asked in the September 2017 LET (Social Science )
examination for HighSchool Teachers. It was a multiple choice question,
and the correct answer is ---
TO MAKE MAXIMUM PROFITS
Eloisa Dela Cruz
THE BEHAVIOR OF PROFIT-MAXIMIZING FIRMS

The Behavior of Profit-Maximizing Firms

 THE BEHAVIOR OF PROFIT-MAXIMIZING FIRMS

A profit-maximizing firm chooses the technology that

minimizes its
costs for a given level of output.
CLASS

Paano daw kumilos ang isang normal na companya na talaga

namang itinatag para kumita ng malaki . This is one of the
reasons why there is a course named ,Economics . To Increase
profits for companies and increase the GDP of the economies of
every nation . Para gumanda ang Economiya. Yung para sa
companies , Microeconomics yun , ang para sa mga Bansa at
mundo , That’s Macroeconomics.

Eloisa Dela Cruz

CLASS

Paano ginagawa itong goal na ito?

1. The firm must know ilang number of quantity ang dapat iproduce niya?

2. Anong Technology ba ang gagamitn para maiproduce ang ganito karami?

3. Gaano kadaming raw materials ang kailangan bilhin para sa technology na ito?

A profit-maximizing firm chooses the technology that

minimizes its

costs for a given level of output.

Eloisa Dela Cruz
CLASS
1. How much output to produce? 500,000 copies.

Example: a book publisher company. Either -

G. Miranda , Rex Bookstore or Vicente Publishing House

These companies send out sales representatives to get orders from

many Bookstores and School Supply Stores of Schools and Universities.

Each sales representative will have his own orders to be added to the
orders of others . Example – Science Book A has a total order of
500,000 copies.

There is your answer to question no 1.

Eloisa Dela Cruz
CLASS
2. What Technology to be used?

A B C
a. How much will it cost to print 500,000 copies using A? How much is machine A?

b. How much will it cost to print 500,000 copies using B? How much is machine B?

c. How much will it cost to print 500,000 copies using C? How much is machine C?

Eloisa Dela Cruz

CLASS
3. After Choosing which one of A,B, or C to use, the 3rd question is
how much raw materials are to be used for that certain machine?

A B C

Eloisa Dela Cruz

 COMPUTATION OF PROFITS IN ECONOMICS

We assume that firms are in business to make a profit and that a

firm’s behavior is guided by the goal of maximizing profits.
What is profit?
Profit is the difference between total revenue and total cost:

profit = total revenue - total cost

PROFIT (ECONOMIC PROFIT) -The difference between total revenue and total cost.

TOTAL REVENUE - The amount received from the sale of the product (P x Q ).

Total revenue = selling price x quantity

 COMPUTATION OF PROFITS IN ECONOMICS

total cost (total economic cost)

The total of (1) out-of pocket costs and
(2) opportunity cost of all factors of production

Out-of-pocket costs are sometimes referred to as

explicit costs or
accounting costs.
These refer to costs as an accountant would calculate profit.
 COMPUTATION OF PROFITS IN ECONOMICS

Economic costs
Include the opportunity cost of every input.
These opportunity costs are often referred to as
implicit costs. The term profit will from here on refer to
economic profit. So whenever we say

Profit = total revenue - total cost,

what we really mean is
economic profit = total revenue - total economic cost –accounting cost
or = total revenue – (total economic costs +accounting costs)

.
 CLASS
One of the key words in our topic is PROFITS
So we compute profits in Economic Terms
Why Economic terms ? -
– because computation of profits in Eco is different from Accounting

So , we have 2 terminologies- Accounting Profits and Economic Profits

1. Accounting Profits
2. Economic Profits

Eloisa Dela Cruz

CLASS

General Formula
Profits = Selling Price - Cost Price

In Economics , there are Cost Prices , there are 2 Costs

1. Accounting Costs

2. Economic Costs

Eloisa Dela Cruz

CLASS
1. Accounting Costs are also called
a. Explicit Costs (Seen)
b. Out –of –pockets Costs
2. Economic Costs are also called
a. Implicit Costs (Hidden)
b. Opportunity Cost

Eloisa Dela Cruz

 CLASS
Accounting Costs are “what you see are what you get costs”
kung ano lang yung nakikita mo , yung lang ang computed
explicit costs or out-of-pocket costs.
Example : sale of a pair of pants from Divisoria because your friend asked you
to buy another pair kasi nagustuhan niya ung bagong bili mong pants
Profit = Selling Price – Cost Price
100 = 300 - 200
Your accounting cost is 200 , that’s your explicit cost or out of pocket cost
What you see is what you get --- 200

Eloisa Dela Cruz

 CLASS
ON THE OTHER HAND
Economic Costs are your implicit costs or opportunity costs
(we will discuss Opportunity cost concept later in the next slides)
These are “nakatagong costs”
In the same example
You did not include in the computation of the cost, the amounts of the following:
1. Fare to go to Divisoria (it was a special trip)
2. Your Merienda when you got hungry
In economics , we include and add these costs in the computation of our profits.

Eloisa Dela Cruz

 NORMAL RATE OF RETURN

When companies compute their earnings , they don’t only compute their
PROFITS ,
they also compute the

RATE OF RETURN
 NORMAL RATE OF RETURN

Whenever Resources Are Used To Invest In A Business,

There Is An Opportunity Cost. (Opportunity Lost)

Ex: Instead of opening a candy store,

you could put your funds into an alternative use
1. such as a certificate of deposit or
2. a government bond,
both of which earn interest.

Instead of using its retained earnings to build a new plant,

1. a firm could earn interest on those funds or
2. pay them out to shareholders.
 CLASS
Companies compute for their profits by totaling all costs
• What are the costs ? These are the raw materials needed to transform into
products.
1. land
2. labor
3.capital
• Land – the place where the company does its business transactions or the
factory location where it manufactures its products. RENTAL COSTS
• Labor – the employees that work together to get the outputs (goods and
services ) done. SALARY OR WAGE COSTS
• Capital - the funds used to finance the business , the big machinery used
to manufacture the goods and services INTEREST COSTS
• These costs are totaled to compute the total costs
Eloisa Dela Cruz
 NORMAL RATE OF RETURN
A simple example will illustrate the concepts of a normal rate of return
being part of total cost.
Suppose that Sue and Ann decide to start a small business selling turquoise
belts in the Denver airport. To get into the business, they need to invest in
a fancy pushcart. The price of the pushcart is $20,000 with all the
displays and attachments included.
Suppose that Sue and Ann estimate that they will sell 3,000 belts each
year for $10 each. Further assume that each belt costs $5 from the
supplier. Finally, the cart must be staffed by one clerk, who works for an
annual wage of $14,000. Is this business going to make a profit?

To answer this question, we must determine total revenue and total cost.
First, annual revenue is $30,000 (3,000 belts $10). Total cost includes the
cost of the belts—$15,000 (3,000 belts at $5)—plus the labor cost of
$14,000, for a total of $29,000. Thus, on the basis of the annual revenue
and cost flows, the firm seems to be making a profit .

See table in next slide

Accounting profits with a profit of $1,000.00

Makikita dito sa table 6 na meron profit si Sue. She paid

The belts , she paid the labor and the total was 29,000 costs
Her sales were 30,000, thus she has profit of $1,000. These are her
accounting profits
But these are merely her Accounting Profits , In Economics, we have to
include the Economic Cost, to be able to get the Economic Profits.

Eloisa Dela Cruz

Economic costs explained -- hidden costs
In lay man’s terms, what do you
really mean by economic costs .
Isipin nyo kunwari a man is travelling in Tabuk , sa Mountain Province,
in his car. Accidentally nakasagasa siya ng mga manok sa street. Nagalit
ang mga inhabitants and they demand na bayaran nya ung mga
namatay na manok. So the man counted the chicken na namatay at
nagkwenta 5 chicken X 300 per manok . So magbabayad na sana siya
nang 1500. pero hindi pumayag ung mga inhabitants . 10,000 daw
dapat . Nagulat ung driver and nag demand siya ng explanation. Bakit
daw ganoon . Ang sabi sa kanya. The reason is kailangan bayaran niya
rin ung mga i iitlog pang mga manok at ung mga dapat pang mga
ibentang malalaking manok na hindi na lumaki dahil sa nangyari.
Ganyan din ang mga Economic cost , hidden cost na dapat idagdag ,
dapat iconsider sa pag to total ng costs. Ito yung mga nakatagong cost.
Eloisa Dela Cruz
CLASS Rationale of Economic Costs

• In the case of Sue , kailangang idagdag ung cost na nawala dahil nag
invest ng 20,000.
• kung hindi ibinili ito ng cart , Dapat sana it is in the bank earning at the
prevailing rate of interest which is mentioned as 10% ( the market
interest rate available.) So 10% x 20,000 = 2,000 (in the table the
normal return / opportunity cost of capital ($20,000x .10) = 2,000.00
• kaya ang tawag dito ay Opportunity cost or opportunity lost or implicit
cost or hidden cost
. See table inDela
Eloisa next
Cruz slide
 CLASS

If this is added to the cost of 15,000 and 14,000 + 2.000, the total is
31,000 .
30,000-31,000 = -1,000
Therefore instead of a profit , Sue suffered a loss.
This is the explanation of Economic Costs .
In Economics , we need to add hidden costs because these costs could have been
invested in another opportunity venture and could have earned better.

Eloisa Dela Cruz

CLASS Rationale of Economic Costs

What is the rationale of Economics, why , it includes the hidden costs in the
computation of profits .
Bakit ginagawa ito sa economics, anong buti ang hatid ng ganitong systema ?
You need to explain this to your students. , so they will understand the lesson
and the rationale.
The reason is kailangan ng mga investors , owners of companies, stockholders na
makita nila sa computation ng profits na kung ininvest yong mga pera sa ibang
earning alternative nakuha pa rin yung kita na iyon
Look at the 2,000 , isinama iyon sa computation ng profit ni Sue and when it
was added lumabas na with the 2,000 capital invested there was a 1,000
loss. Nakita na , mas dapat na ininvest na lang sa banko . Kumita pa ng 2,000 ,
hindi ka pa na pagod and nalugi ng 1,000 . and the 29,000 na cost ng belt
and labor could have been invested in another venture instead. Hindi ka pa
nalulugi or nadadapa , alam mo na . And this will influence your decision .
Remenber the goal of every established firm is to MAXIMIXE PROFITS.

Eloisa Dela Cruz

 NORMAL RATE OF RETURN

The most important hidden cost that is included in economic cost

is the opportunity cost of capital.
The way we treat the opportunity cost of capital
is to add a NORMAL RATE OF RETURN to capital as part of economic
cost.
CLASS the most important hidden cost is capital

• The most important hidden cost that is included in economic cost is the opportunity cost of capital

• Why , what are the other hidden costs aside from capital?

1 rental cost ---- cost of borrowed land

2. salary cost ---- cost of borrowed labor

3. capital cost ---- cost of borrowed capital

or interest

So the other two are rental cost and wages of salary cost.

“The most important hidden cost that is included in economic cost is the opportunity cost of capital “

Why , because it is the most liquid of all these raw materials , mas madaling pagkakitaan .

The land , will still have to be developed and built needing extra money

The labor , will still have to be trained and requires experience before it can be tapped

While capital can easily be invested right away , sometimes just needing to be withdrawn.

Eloisa Dela Cruz

CLASS pls explain the hidden rental cost and salary cost

Hidden rental cost –

Example : suppose Sue has a vacant lot in front of her house which is
near a busy area in the community and Sue stationed her belt cart
using the empty space of her lot.
In computing for the cost, she should include the opportunity cost of
renting out that land to somebody else. Lets say $100 a month or
$1,200 annually.
If we include that, the total cost would be
Profit = 30,000 – (15,000+ 14,000+2,000 +1,200)
= 30,000 - (32,200)
Losses = -2,200
Eloisa Dela Cruz
CLASS pls explain the hidden rental cost and salary cost

Hidden salary cost –

Example : suppose Sue resigned from her job to mind the belt business that she put up
and still using the empty space of her lot.

In computing for the cost, she should include the opportunity cost of renting out that land
to somebody else. Lets say $100 a month or $1,200 annually and the salary that she
should be earning if she is still in her former job. Let’s say she’s getting $600 a month or
$7200 annually. We now remove the labor of 14,000

If we include that, the total cost would be

Profit = 30,000 – (15,000+ 2,000 +1,200 +7,200 )

= 30,000 - (25,400)

profit = 4,600

Therefore we now have a profit of $4,600

Eloisa Dela Cruz

CLASS pls explain the hidden rental cost and salary cost

So you can see the different scenarios that Sue can choose from .She can add
and remove costs depending of the different situations.
She can choose to hire or man the business herself. (and give different salary
levels.)
She can choose to rent a certain space at the Mall or use her own vacant lot if
she has one.
She can combine the different raw material cost and make them work to her
advantage .
She can plot all this things , compare and decide on a more feasible resolution.
Again with this , Economics helps achieve the ultimate goal of a firm.-
MAXIMUM PROFITS
this is one of the behaviors of a profit maximizing firm.

Eloisa Dela Cruz

 RATE OF RETURN

Rate Of Return is the annual flow of net income generated by an

investment expressed as a percentage of the total investment.

Ex: If someone makes a $100,000 investment in capital

to start a small restaurant and the restaurant produces a flow
of profit of $15,000 every year,

we say the project has a “RATE OF RETURN” of 15 percent.

Sometimes we refer to the RATE OF RETURN as the
Yield Of The Investment.
CLASS rate of return (RR) explained

• . Ex: If someone makes a $100,000 investment in capital

• to start a small restaurant and the restaurant produces
a flow of profit of $15,000 every year,
we say the project has a “RATE OF RETURN” of 15 percent.
iF the normal rate of return is 10%
Then the rate 15 % is higher than the normal rate of return
iF the company is just earning 8,000 the rate of return is just
8%, that is lower than the 10% normal rate of return

Eloisa Dela Cruz

 RATE OF RETURN

.normal rate of return

A rate of return on capital that is just sufficient to keep owners and
investors satisfied.
For relatively risk-free firms, it should be nearly the same as
the interest rate on risk-free government bonds.
If it were to fall below normal, it would be difficult or impossible for
managers
to raise resources needed to purchase new capital. Owners of the firm
would be receiving a rate of
return that was lower than what they could receive elsewhere in the
economy, and they would have
no incentive to invest in the firm.
CLASS

• The normal rate of return is 10% because it is the market

interest rate available ,that is the same as the interest rate on
risk-free government bonds.
• In our example , the 10% rate was a given value
• Ito raw yung regular rate na on going sa mga banks
• Kung may investment kang gagawin dapat naka abot man
lang dito a 10% rate of return ng investment mo because you
have to compare the opportunity kung dito mo ininvest or sa
iba pa

Eloisa Dela Cruz

 RATE OF RETURN

If the firm has fairly steady revenues and the future looks secure, the normal rate
of return should be very close to the interest rate on risk-free government bonds. A
firm certainly will not keep investors interested in it if it does not pay them a rate of
return at least as high as they can get from a risk-free government or corporate
bond. If a firm is rock solid and the economy is steady, it may not have to pay a
much higher rate. However, if a firm is in a very speculative industry and the future
of the economy is shaky, it may have to pay substantially more to keep its
shareholders happy. In exchange for a risk that the business may falter or even
fail, the shareholders will expect a higher return.
CLASS the normal rate of return defined

So makikita natin dito nagdagdag tayo ang 2000 additional cost

named normal rate of return on capital,
Most advanced firms add these NRR to make sure that the profits
they achieve ay bawi sa rate ng mga banks kung ininvest nila sa mga
banko ang pera nila
Most stock holders will try to find this , naglaan ang company ng
profits higher than the NRR. If the computed profits is 0 (30,000-
30,000) okey pa yung company naka return yung 10% rate sa
pamamagitan ng tubo na naka abot sa 10%.

Eloisa Dela Cruz

CLASS the normal rate of return explained

Kung ang tubo naman ay more than the 10% (30,000-

27000.= 3000) this means na kahit nag NRR pa ng 10% or
2000 positive pa rin ang company .
Still investors will be happy about this , they will stay with the
company and more investors will be attracted still.

Eloisa Dela Cruz

 NORMAL RATE OF RETURN

A normal rate of return

is the rate that is just sufficient to keep owners and
investors satisfied.

If the rate of return were to Fall Below Normal,

it would be difficult or impossible for managers
to raise resources needed to purchase new capital.

Owners of the firm would be receiving a rate of return

that was lower than what they could receive elsewhere
in the economy, and they would have no incentive to
invest in the firm
 NORMAL RATE OF RETURN

When a firm earns a POSITIVE level of profit, it is earning

more than is sufficient to retain the interest of investors.

In fact, positive profits are likely to attract new firms into an

industry and cause existing firms to expand.

When a firm suffers a NEGATIVE level of profit—that is, when

it incurs a loss—it is earning at a rate below that is required
to keep investors happy.
 NORMAL RATE OF RETURN

Such a loss may or may not be a loss as an accountant

would measure it.
Even if a firm is earning a rate of return of 10 percent,
it is earning a below-normal rate of return, or a loss,
if a normal return for its industry is 15 percent.
Losses may cause some firms to exit the industry;
others will contract in size.
Certainly, new investment will not flow into such an
industry.
CLASS
Industries to assure their mighty levels in the economy
establish a high level of industry rate
Most industries require a level higher than the
Normal Rate of Return of Banks.
Example :the network Industry
Channel 7and Channel 2 peg their industry rate at 15% because when they
compute their profits and hit a mark as high as 15% even if they include a 10%
Normal Rate of Return in their computation , they are very sure that their
profits are really pouring in . This reports if seen by investors in their annual
report as they analyze the financial status of the networks. The investors will
stay with the firm or leave the firm by selling their stocks depending on the
financial status compared to the other network. Channel 7 or Channel 2.

Eloisa Dela Cruz

CLASS
This shows the importance of learning the behavior of firms .
They maximize profits
to stay alive in the industry
To even stay on top
To maintain their stockholders
To have more funds and expand
THESE AGAIN ARE BEHAVIORS OF PROFIT MAXIMIZING
FIRMS
Eloisa Dela Cruz
 SHORT-RUN VERSUS LONG-RUN DECISIONS

Firms especially their CEOs and their Presidents, make

decisions

The decisions made by a firm—how much to produce, how to

produce it, and what inputs to
demand—all take TIME into account.
 SHORT-RUN VERSUS LONG-RUN DECISIONS
“A firm’s immediate response to a change in the economic
environment may differ from its response over time.
Consider, for example, a small restaurant with 20 tables that
becomes very
popular. The immediate problem for the owners is getting the
most profit within the constraint of the existing restaurant.
The owner might consider adding a few tables or speeding up
service to squeeze in a few more customers. Some popular
restaurants do not take reservations, forcing people to wait at
the bar. This practice increases drink revenues and keeps
tables full at all times.
At the same time, the owner may be thinking of expanding
the current facility, moving to a larger facility, or opening a
second restaurant. In the future, the owner might buy the
store next door and double the capacity. Such decisions might
require negotiating a lease, buying new equipment, and hiring
more staff. It takes time to make and implement these
decisions”
 SHORT-RUN VERSUS LONG-RUN DECISIONS

Because the character of immediate response differs from

long-run adjustment,
it is useful to define two time periods:
the short run and the long run. Two assumptions define the
short run:
(1)a fixed scale (or) a fixed factor of production) and
(2) no entry into or exit from the industry.

First, the short run is defined as that period during which

existing firms have some fixed factor of production—that is,
during which time some factor locks them into their current
scale of operations.
Second, new firms cannot enter and existing firms cannot exit
 SHORT-RUN VERSUS LONG-RUN DECISIONS

short run
The period of time for which two conditions hold:
1. The firm is operating under a fixed scale (fixed factor) of production,
2. and firms can neither enter nor exit an industry

long run
That period of time for which
1. there are no fixed factors of production: Firms can increase or decrease the scale
of operation, and
2. new firms can enter and existing firms can exit the industry
 THE BASES OF DECISIONS: MARKET PRICE OF OUTPUTS, AVAILABLE
TECHNOLOGY, AND INPUT PRICES

As we said earlier, a firm’s three fundamental

decisions are made with the objective of maximizing
profits. Because profits equal total revenues minus
total costs, each firm needs to know how
much it costs to produce its product and how much
its product can be sold for.
 THE BASES OF DECISIONS: MARKET PRICE OF OUTPUTS, AVAILABLE
TECHNOLOGY, AND INPUT PRICES

In the language of economics, a firm needs to know

three things:
1. The market price of output
2. The techniques of production that are available
3. The prices of inputs
CLASS
In this section of behavior of firms, there are two things we
need to know :
That firms interact in two time zones :
1. Short Run Time Dimension
2. Long Run Time Dimension

Eloisa Dela Cruz

CLASS
• In the short run conditions -- 1 to 6 months

Describes that period of time for which two conditions hold:

1. The firm is operating under a fixed scale (fixed factor)

2. of production,

2. and firms can neither enter nor exit an industry

illustrations :

1. like our sandwich shop , the company cannot increase the size of its grill because in the short
run condition , the firms have just bought the grill and they just found out that sales are
really growing and they have to settle for that newly bought grill

2. at the food court, in the mall , there are stalls that are not patronized by customers but
they cannot just close shop , some have a 6 month contract which have been pre paid and
no matter how much another stall owner would want to replace the unpatronized , he
cannot do so but just wait for the contract to lapse after 6 months and he can have his own
contract.
Eloisa Dela Cruz
CLASS
long run conditions --- 5 to 10 years
• Describes that period of time for which
1. there are no fixed factors of production:
Firms can increase or decrease the scale of operation, and
2.New firms can enter and existing firms can exit the industry
Illustrations :
1. During this situation our very successful burger shop can choose to increase
the capacity of his equipment an buy new ones that match the salability of his
products or some stores which are loosing most of its clients buy some reason
can decide to sell their other equipment and choose to down-size.
2. At this point some firms in the mall have finished their contract and opt not
to renew , giving way to other budding entrepreneurs to replace them and use
that vacant stall in the food court.
Eloisa Dela Cruz
CLASS
In the Hierarchy of Management , we learned that there are 3 levels in the Vertical Hierarchy
of Management

1.Top Management CEO, President OIC Vice Presidents

2. Middle Management all managers in between the Top Managers and

the First Line Managers

3. First Line Managers the first level of managers handling

the staff , with titles such as s

supervisor , chief,

Eloisa Dela Cruz

CLASS
These 3 level of managers perform their tasks in the two time
zones
1. Top management - work in the Long Run Time
Dimension
2. Middle Managers - work in the Short Run Time
Dimension
3 1st Line Managers - work in the Short Run Time
Dimension
Eloisa Dela Cruz
CLASS
Time dimension differ from one company to another.
Manong FishBall Vendor
as the owner of his sole proprietorship has a different
Long Run and ShortRun
from the owner of Ayala Corporation.

Eloisa Dela Cruz

CLASS
What decisions do they make..
Manong FishBall Vendor
“dito pa rin ba ako magtitinda bukas,
hindi kaya ako paalisin mayamaya lang “
“May puhunan kaya ako para bukas”

For the owner of Ayala Corporation

10 – 20 years is not long enough.
Eloisa Dela Cruz
 THE BASES OF DECISIONS: MARKET PRICE OF
OUTPUTS, AVAILABLE TECHNOLOGY, AND INPUT
PRICES
CLASS

Profit = Sales or Total Revenue – Total cost

Managers want to increase the profits by increasing sales and

decreasing total cost

Eloisa Dela Cruz

 CLASS

Profit = Sales or Total Revenue – Total cost

How do you increase sales – by increasing the price or the quantity

How do you decrease cost – by decreasing the
price or quantity of land
price or quantity of labor
price or quantity of capital

Eloisa Dela Cruz

 CLASS
How do you decrease cost –
by decreasing the :
1. price or quantity of land – hard to do
– you’ll lose your factory or office
- your raw materials and product will get
adulterated
2. price or quantity of capital – Hard to do
- you have no funds to spend
- you ‘ll lessen your machinery and technology

Eloisa Dela Cruz

 CLASS

How do you decrease cost –

3. Price and quantity of labor – yes , that’s easy
- retrench or lay-off your laborers for redundancy , they can not complain
especially those who were left , they might get laid-off too

SO WHAT IS THE LESSON HERE

Employees must be the best that they can be , they must not only be
efficient , they must also be effective , so that , when unavoidable
circumstances like these come along , they will be inelastic and be
unsubstitutable.
Tell your students to study hard and absorb as much as they can
during the formative years of learning, nothing can replace stock
knowledge. (Even in Dementia and Alzheimer's) the last to go.

Eloisa Dela Cruz

 THE BASES OF DECISIONS: MARKET PRICE OF
OUTPUTS, AVAILABLE TECHNOLOGY, AND INPUT
PRICES

The production technology –

The quantitative relationship between inputs and outputs
 THE BASES OF DECISIONS: MARKET PRICE OF OUTPUTS,
AVAILABLE TECHNOLOGY, AND INPUT PRICES

.
1. labor-intensive technology
Technology that relies heavily on human labor of capital.

2. capital-intensive technology
Technology that relies heavily on capital instead of human
labor.
 CLASS

Two kinds of technology

1. Labor intensive -makes use of more
human labor rather than machinery
2. Capital intensive –makes use of more
machinery rather than manpower

Eloisa Dela Cruz

 CLASS

It is part of a company’s long run decision making on what kind of

technology to choose
Labor intensive or capital intensive
Because it takes into consideration
1. The price of the technology and the price of labor
2. The speed it will take to finish the job
3. The availability and prices of inputs needed to run the machinery or
not to use any machinery at all.

Eloisa Dela Cruz

 THE BASES OF DECISIONS: MARKET PRICE OF
OUTPUTS, AVAILABLE TECHNOLOGY, AND INPUT
PRICES

Production is the process through which inputs are

combined and transformed into outputs.

optimal method of production

The production method that minimizes the cost.
 THE BASES OF DECISIONS: MARKET PRICE OF
OUTPUTS, AVAILABLE TECHNOLOGY, AND INPUT
PRICES
MARGINAL PRODUCT AND THE LAW OF DIMINISHING
RETURNS
 CLASS

This is a table of Krusty Krab Restaurant’s employee requirements.

At 0 employees , no Krusty Kraby sandwiches produced
At 1 employee Spongebob, 10 sandwiches
At 2 employees Patrick joins in 15 additional , total of 25 sandwhiches
At 3 employees , Sandy joins the 2 , 10additional , total of 35 sandwiches
At 4 employees, Squidward joins the 3, 5 additional , total of 40
At 5 employees, Mrs. Puff joins the 4, 2 additional , total of 42
At 6 employees , Pearl joins the 5 , 0 additional , still total of 42 sandwhiches

Eloisa Dela Cruz

 CLASS

This is a table of Krusty Krab Restaurant’s employee

requirements.
This table together with the two graphs visually reflects
the optimum number of employees that Mr. Krabs should
employ , that will give the optimum level of labor force
(meaning less labor cost yet more output of sandwiches )
The table shows 2 employees have the most additional
output if 15 that any other combination of number of
employees. With the highest level of average of 12 5 per
employee. The highest in the table .

Eloisa Dela Cruz

 CLASS

These data are supported by the total

product and marginal product curves,

The marginal product curve shows 2 employees have the most

output among the other combinations.
The total product curve shows how many total employees can still
help each other cook and still add to the number of burgers being
cooked. The graph and table states that after 5 employees , the 6th
employee can not give any increase in the number of burgers being
cooked on the grill.
Eloisa Dela Cruz
 THE BASES OF DECISIONS: MARKET PRICE OF
OUTPUTS, AVAILABLE TECHNOLOGY, AND INPUT
PRICES

marginal product
The additional output that can be
produced by adding one more
unit of a specific input, ceteris
paribus.
MARGINAL PRODUCT AND THE LAW OF DIMINISHING
RETURNS

law of diminishing returns

When additional units of a variable input are
added to fixed inputs, after a certain point, the
marginal product of the variable input declines.
 CLASS

These data are supported by the total

product and marginal product curves,

The marginal product curve shows 2 employees have the most

output among the other combinations.
The total product curve shows how many total employees can still
help each other cook and still add to the number of burgers being
cooked. The graph and table states that after 5 employees , the 6th
employee can not give any increase in the number of burgers being
cooked on the grill.
Eloisa Dela Cruz
 CLASS
• law of diminishing returns
When additional units of a variable input are added to fixed inputs,
after a certain point, the marginal product of the variable input
declines.
The law of diminishing returns , specifically the Law of Diminishing
Product.
When additional units of variable __no. of employees are added to
fixed inputs___the grill – a capital intensive technology, after a
certain point (2 employees) , the marginal product of the variable
input (no of employees )decline._

Eloisa Dela Cruz

MARGINAL PRODUCT AND THE LAW OF DIMINISHING
RETURNS
Diminishing returns, or diminishing marginal product, begin
to show up when more and more units of a variable input are
added to a fixed input, such as the scale of the plant.

Recall that we defined the short run as that period in which

some fixed factor of production constrains the firm
It then follows that diminishing returns always apply in the
short run and that in the short run, every firm will face
diminishing returns.
This means that every firm finds it progressively more difficult
to increase its output as it approaches capacity production.
MARGINAL PRODUCT AND THE LAW OF DIMINISHING
RETURNS
average product
The average amount produced by each unit
of a variable factor of production.
 MARGINAL PRODUCT AND THE LAW OF DIMINISHING
Average product
RETURNS
is the average amount produced by each unit of a variable factor of production.

At our sandwich shop with one grill, that variable factor is labor. In Table 7.2, you saw
that the first two workers together produce 25 sandwiches per hour.

Their average product is therefore 12.5 (25 ÷ 2).

The third worker adds only 10 sandwiches per hour to the total.
These 10 sandwiches are the marginal product of labor.
The average product of the first three units of labor, however, is 11.7 (the average of 10,
15, and 10).

Stated in equation form, the average product of labor is the total product divided by total
units of labor:
 MARGINAL PRODUCT AND
THE LAW OF DIMINISHING RETURNS
 CLASS

Most Economists know that the intersection of the

Total Average Product and
the Marginal Product Curve
is the optimum number of units of labor. 2
By employing two employees , the company achieves
the optimum (the Least Cost) number of employees .

Eloisa Dela Cruz

 PRODUCTION FUNCTIONS WITH TWO VARIABLE FACTORS OF
PRODUCTION

So far, we have considered production functions with

only one variable factor of production.

However, inputs work together in production. In

general, additional capital increases the productivity
of labor. Because capital—buildings, machines, and so
on—is of no use without people to operate it, we say
that capital and labor are

COMPLEMENTARY INPUTS.
 PRODUCTION FUNCTIONS WITH TWO VARIABLE FACTORS OF
PRODUCTION
INPUTS (FACTORS OF PRODUCTION) ARE
COMPLEMENTARY.

CAPITAL
enhances the productivity of
LABOR.

However, inputs can also be substituted for one another. If labor becomes
expensive, firms can adopt labor-saving technologies; that is, they can
substitute capital for labor. Assembly lines can be automated by replacing
human beings with machines, and capital can be substituted for land when
land is scarce. If capital becomes relatively expensive, firms can substitute
labor for capital. In short, most goods and services can be produced in a
number of ways through the use of alternative technologies. One of the key
decisions that all firms must make is which technology to use.
PRODUCTION FUNCTIONS WITH TWO VARIABLE FACTORS OF
PRODUCTION
 CLASS
In the previous graphs we were able to make a decision on the number of employees to hire.

We decided on 2 employees as the best number of employees to employ because 2 employees

gave more additional sandwiches at the least cost of employees possible.

Given the data in table 7.3 we are guided by information gathered for our company:

1. We are given 5 choices of technology to use

A,B,C,D,E

A uses 2 machines 10 laborers

B uses 3 machines 6 laborers

C uses 4 machines 4 laborers

D uses 6 machines 3 laborers

E uses 10 machines 2 laborers

Eloisa Dela Cruz

 CLASS
In the previous graphs we were able to make a decision on the number of employees to hire.

We decided on 2 employees as the best number of employees to employ because 2 employees

gave more additional sandwiches at the least cost of employees possible.

Given the data in table 7.3 we are guided by information gathered for our company:

1. We are given 5 choices of technology to use

A,B,C,D,E

A uses 2 machines 10 laborers

B uses 3 machines 6 laborers

C uses 4 machines 4 laborers

D uses 6 machines 3 laborers

E uses 10 machines 2 laborers

Eloisa Dela Cruz

 CLASS
A,B,C,D,E

A uses 2 machines 10 laborers

B uses 3 machines 6 laborers

C uses 4 machines 4 laborers

D uses 6 machines 3 laborers

E uses 10 machines 2 laborers

Eloisa Dela Cruz

 PRODUCTION FUNCTIONS WITH TWO VARIABLE FACTORS OF
PRODUCTION

To choose a production technique, the firm must look to input

markets to learn the current market prices of labor and
capital.

What is the
1. wage rate (PL),
2. cost per hour of capital (PK)?

The right choice among inputs depends on how productive an

input is and what its price is.
PRODUCTION FUNCTIONS WITH TWO VARIABLE FACTORS OF
PRODUCTION
 CLASS
In this table we are given information of the prices per unit of labor to man our
machine and the amount per hour of machine hours employed to make the
output we need and knew about at the beginning of the lesson when we answered
the first question , the number of units of output needed or forecasted..

We decided on 2 employees as the best number of employees to employ because 2

employees gave more additional sandwiches at the least cost of employees possible.

table 7.3 computes for us in columns (4) and (5)

We are given 10 choices of technology to use

Eloisa Dela Cruz

 CLASS
We analyze table 7.4 and distinguish which among the 5 are:

1. capital intensive or

2. labor intensive technologies

Capital Labor

A 2 10 labor intensive

B 3 6 labor intensive
C 4 4 equally labor and capital
D 6 3 Capital intensive
E 10 2 Capital intensive

Eloisa Dela Cruz

 CLASS
We analyze table 7.4 gives us a choice between

1. capital intensive and

2. labor intensive technologies

Capital Labor 4 5 choice

A 2 10 12 52 4
B 3 6 9 33 4
C 4 4 8 24 4
D 6 3 9 21 4
E 10 2 12 22 4
Still the choice is to use the labor price of 1 and not 5
But which technology gives the least cost in column 4-
technology C with a total cost of 8
Eloisa Dela Cruz
 CLASS

So far we have looked into the behavior of firms

That firms have the ultimate goal of maximizing their profits
through satisfying their costumers.
They make decisions on producing the best quality of goods and services by
Deciding on three basic questions on :
,1. how they decide on the number of units to be made
2. The type and number of units and the prices of technology to use
3. And the number and prices of inputs to use
We also learned that they decide for the long run and the short run time
dimensions
Eloisa Dela Cruz
 CLASS

Firms compute their profits and use the NRR (Normal Rate of Return ) to
make sure that their industry rating is acceptable to investors and the
top management to keep their industry rating and maintain their
supremacy in the market and the economy.
Notice the big companies , they are the companies that are always heard
during this
Covid Pandemic times because they have the capital , the power and the
arsenal to make things happen because of vigilant long run planning and
carefully using their resources to the fullest
They also have to deal with the environment , especially the Political
environment that gives the go signals and the hindrances.
And of course, ultimate si God , without Whom , nothing will be existent.
Eloisa Dela Cruz
CLASS

Eloisa Dela Cruz