Technology, profit maximization and theory of firm and industry supplyThe theory of the firm consists of a number of economic theories that describe the nature of the firm, company, or corporation, including its existence, behavior, structure, and relationship to the market.In simplified terms, the theory of the firm aims to answer these questions:Existence – why do firms emerge, why are not all transactions in the economy mediated over the market? 1. Boundaries – why is the boundary between firms and the market located exactly there as to size and output variety? Which transactions are performed internally and which are negotiated on the market? 2. Organization – why are firms structured in such a specific way, for example as to hierarchy or decentralization? What is the interplay of formal and informal relationships? 3. Heterogeneity of firm actions/performances – what drives different actions and performances of firms? Firms exist as an alternative system to the market-price mechanism when it is more efficient to produce in a non-market environment. For example, in a labor market, it might be very difficult or costly for firms or organizations to engage in production when they have to hire and fire their workers depending on demand/supply conditions. It might also be costly for employees to shift companies every day looking for better alternatives. Thus, firms engage in a long-term contract with their employees to minimize the cost. In economics, profit maximization is the (short run) process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem. The total revenue–total cost method relies on the fact that profit equals revenue minus cost, and the marginal revenue–marginal cost method is based on the fact that total profit in a perfectly competitive market reaches its maximum point where marginal revenue equals marginal cost. Total revenue - total cost method:To obtain the profit maximising output quantity, profit is equal to total revenue (TR) minus total cost (TC). Marginal revenue-marginal cost method:An alternative argument says that for each unit sold, marginal profit (Mπ) equals marginal revenue (MR) minus marginal cost (MC). Then, if marginal revenue is greater than marginal cost, marginal profit is positive, and if marginal revenue is less than marginal cost, marginal profit is negative. When marginal revenue equals marginal cost, marginal profit is zero. (industry?)An export supply curve is the difference between the quantity that foreign producers supply minus the quantity that foreign consumers demand, at each price. In equilibrium, import demand = export supply, domestic demand – domestic supply =foreign supply – foreign demand. In equilibrium, world demand = world supply 5. Production costs in short run vs long run and cost minimization problem. The short run is a period of time when there is at least one fixed factor of production i.e. some factor inputs that cannot be altered. This is usually fixed capital such as machinery and the amount of factory space available. Output increases when more units of variable factors (labour and raw materials) are added to fixed factors. Hence in the short run a firm will have fixed and variable costs of production. Total cost = fixed cost + variable cost. Short Run Cost Curves:
A change in variable costs: A rise in the variable costs of production leads to an upward shift both in marginal and average total cost. The firm is not able to supply as much output at the same price. The effect is that of an inward shift in the supply curve of a business in a competitive market.
The Long-run: Period of time long enough for firms to change the quantities of all resources employed including capital and new factories. In the long run, there is no distinction between FC and VC because all resources (therefore costs) are variable in the long run. In the long run, an industry and the individual firms it comprises can undertake all desired resource adjustments or in other words, they can change the amount of all inputs used. The long run allows sufficient time for new firms to enter or for existing firms to leave an industry. The long-run cost curve: The green, orange, yellow, pink, blue curves are separate short run curves. The long run curve is created by combining all the lowest ATC at any output of the short run curves. Costs help determine the resource mix a firm will use, how much output a firm will produce, whether profit is realized, and whether a firm will continue to produce in the long run. Production costs are broken down into two broad categories: fixed costs and variable costs. Total costs are the sum of all fixed and variable costs and can be expressed as: TC = TFC + TVC
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