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A. Theory of

Production and Marginal Products

1. The relationship between the quantity of output (such as wheat, steel, or automobiles) and the quantities of inputs (of labor, land, and capital) is called the production function. Total product is the total output produced. Average product equals total output divided by the total quantity of inputs. We can calculate the marginal product of a factor as the extra inputs constant. output added for each additional unit of input while holding all other

2. According to the law of diminishing returns, the marginal product of each input will generally decline as the amount of that input increases, when all other inputs are held constant.

3. The returns to scale reflect the impact on output of a balanced increase in all inputs. A technology in which doubling all inputs leads to an exact doubling of outputs displays constant returns to scale. When doubling inputs leads to less than double (more than double) the quantity of output, the situation is one of decreasing (increasing) returns to scale.

4. Because decisions take time to implement, and because

capital and other

factors are often very long-lived, the reaction of production may change over different time periods. The short run is a period in which variable factors, such as labor or material inputs, can be easily changed but fixed factors cannot. In the long run, the capital stock (a firm's machinery and factories) can depreciate and be replaced. In the long run, all inputs, fixed and variable, can be adjusted.

5. Technological change refers to a change in the underlying techniques of production, as occurs when a new product or process of an old product or process is improved. In such situations, the same production is invented or output is

produced with fewer inputs or more Technological change shifts the

output is produced with the same inputs. production function upward.

6. Attempts to measure an aggregate

production function for the American

economy tend to corroborate theories of production and marginal products. In the twentieth century, technological change increased the productivity of both labor and capital. Total factor productivity (measuring the ratio of total output to total inputs) grew at around 11Ú2 percent per year over the twentieth century, although from the 1970s to the mid-1990s the rate of productivity growth slowed markedly and real wages stopped growing. But underestimating the importance of new and improved products may lead to a significant underestimate of productivity growth. B. Business Organizations 7. Business firms are specialized organizations devoted to managing the process of production. 8. Firms come in many shapes and sizes with some economic activity in tiny one-person proprietorships, some in partnerships, and the bulk in corporations. Each kind of enterprise has advantages and disadvantages. Small businesses are flexible, can market new products, and can disappear quickly. But they suffer from the fundamental disadvantage of being unable to accumulate large amounts of capital from a dispersed group of investors. Today's large corporation, granted limited liability by the state, is able to amass billions of dollars of markets. capital by borrowing from banks, bondholders, and stock

9. In a modern economy, business corporations produce most goods and services because economies of mass production necessitate that output be produced

at high volumes, the technology of

production requires much more

capital than a single individual would willingly put at risk, and efficient production requires careful management and coordination of tasks by a centrally directed entity
1. Explain the differences between product advertising and institutional advertising and the

variations within each type. Product advertisements focus on selling a good or service and take three forms: Pioneering advertisements tell people what a product is, what it can do, and where it can be found; competitive advertisements persuade the target market to select the firm's brand rather than a competitor's; and reminder advertisements reinforce previous knowledge of a product. Institutional advertisements are use to build goodwill or an image for an organization. They include advocacy advertisements, which state the position of a company on an issue, and pioneering, competitive, and reminder advertisements, which are similar to the product ads but focused on the institution.
2. Describe the steps used to develop, execute, and evaluate an advertising program. The

promotion decision process can be applied to each of the promotional elements. The steps to develop an advertising program include identify the target audience, specify the advertising objectives, set the advertising budget, design the advertisement, create the message, select the media, and schedule the advertising. Executing the program requires pretesting, and evaluating the program requires posttesting.
3. Explain the advantages and disadvantages of alternative advertising media.

Television advertising reaches large audiences and uses picture, print, sound, and motion; its disadvantages, however, are that it is expensive and perishable. Radio advertising is inexpensive and can be placed quickly, but it has no visual element and is perishable. Magazine advertising can target specific audiences and can convey complex information, but it takes a long time to place the ad and is relatively expensive. Newspapers provide excellent coverage of local markets and can be changed quickly, but they have a short life span and poor color. Yellow pages advertising has a long use period and is available 24 hours per day; its disadvantages, however, are that there is a proliferation of directories and they cannot be updated frequently. Internet advertising can be interactive, but its effectiveness is difficult to measure. Outdoor advertising provides repeat exposures, but its message must be very short and simple. Direct mail can be targeted at very selective audiences, but its cost per contact is high.
4. Discuss the strengths and weaknesses of consumer-oriented and trade-oriented sales

promotions. Coupons encourage retailer support but may delay consumer purchases. Deals reduce consumer risk but reduce perceived value. Premiums offer consumers additional merchandise they want, but they may be purchasing only for the premium. Contests create involvement but require creative thinking. Sweepstakes encourage repeat purchases, but sales drop after the sweepstakes. Samples encourage product trial but are expensive. Loyalty programs help create loyalty but are expensive to run. Displays provide visibility but are difficult to place in retail space. Rebates stimulate demand but are easily copied. Product placement provides a positive message in a noncommercial setting but is difficult to control. Trade-oriented sales promotions include (a) allowances and discounts, which increase purchases but may change retailer ordering patterns, (b) cooperative advertising, which encourages local advertising, and (c) salesforce training,

which helps increase sales by providing the salespeople with product information and selling skills.
5. Recognize public relations as an important form of communication. Public relations

activities usually focus on communicating positive aspects of the business. A frequently used public relations tool is publicity. Publicity tools include new releases and news conferences. Nonprofit organization often use public service announcements.