LECTURE NOTE 1
Purposes of Business and Business Education
The Purpose of Business
The purpose of a business firm is not simply to
make a profit, but is to be found in its very
existence as a community of persons, who in
various ways are endeavoring to satisfy their
basic needs and who form a particular group at
the service of the whole society.” (Pope John
Paul II, Centesimus Annus, para 35)
Foundational Ethical Principles
Respect for the dignity of persons
 Each person is an image of God and
endowed with irreducible dignity or
value.
 United Nations’ 1948 Declaration of
Universal Human Rights
 “Work is for man rather than man for
work.”
Contribution to the common good
 “the sum total of social conditions which
allow people, either as groups or as
individuals, to reach their fulfillment
more fully and more easily”
MANAGEMENT EDUCATION IS A NORMATIVE
ENDEAVOR
A study of what should be (correct standards of
good or bad, right or wrong, based on the best
reasons)
Profession Purpose
Doctor Heal patient
Lawyer Seek justice
Teacher Educate students
Business Create value
The Challenge
“The Business Schools must hone their ability to
certify that their graduates have the character
and integrity to use the knowledge gained for
the benefit of society rather than the abuse of
society.”
- From the Wall Street Journal
6 Practical Principles for Business
Meeting the needs of the world through the
creation and development of goods and
services
 Businesses that produce goods which are
truly good and services which truly serve
contribute to the common good.
 Businesses maintain solidarity with the
poor by being alert for opportunities to
serve otherwise deprived and
underserved populations and people in
need.
Organizing good and productive work
 Businesses make a contribution to the
community by fostering the special
dignity of human work.
 Businesses provide, through subsidiarity,
opportunities for employees to exercise
appropriate authority as they contribute
to the mission of the organization.
Creating sustainable wealth and distributing it
justly
 Businesses model stewardship of the
resources– whether capital, human or
environmental—that they have received.
 Businesses are just in the allocation of the
resources to all stakeholders: employees,
customers, investors, suppliers and the
community.
LECTURE NOTE 2
Cost and Production Theory 1
The Firm
 A firm is an organization that transforms
resources (inputs) into products (outputs).
Firms are the primary producing units in a
market economy.
 Provide value via goods and services
produced
 Create employment
 Receive profits, to grow and to continue
fulfill its roles
 An entrepreneur is a person who organizes,
manages, and assumes the risks of a firm,
taking a new idea or a new product and
turning it into a successful business.
Basic Types of Firms
 Service- provides services for sales
(education, healthcare, etc.)
 Merchandising- provides goods for sale
as intermediate channels (sari-sari
stores, dealers, distributors, etc.)
 Manufacturing- produces goods for sale
(factory, processing plant, milling
company, etc.)
Costs and The Firm
Why is an understanding of costs important?
 Cost behavior affect profit behavior
 Profits determine the survival and
sustainability of a firm
 Profits determine a firm’s ability to
continue to provide employment and
create quality goods and services; to
continue to serve people and the
economy
Cost Theory I
(Especially applicable to Service and
Merchandising Firms)
 Fixed cost (FC): costs that do not vary
with output
 Variable cost (VC): costs that vary with
output
 Total cost (TC): TFC + TVC
 Profits = Total Revenue – Total Costs
Cost Examples
Fixed cost
 Property taxes
 Mortgage payments
 Fire insurance premiums
 Delivery truck lease
 Loan instalments
 Administrative costs and salaries
Variable Wages
 Wages of production workers
 Commissions of sales people
 Raw materials
 Electricity to run production machines
 Inventory maintenance costs
 Shipping costs
Choices Open to the Firm
Time Periods
 Short run – VC + FC (some inputs’
quantity cannot be changed)
 Long run – all VC except technology
 Very long run – all VC + technology
Choices
 How best to use existing resources to
maximize profits?
 What new resources to use, given
existing technology, to maximize
profits?
 How to encourage or adapt to the
development of new technology, to
maximize profits?
To maximize profits, in the short run
 When starting a business, keep fixed
costs down only to what’s necessary.
 The only costs a firm has control over
are the variable costs, so they must be
minimized.
 Although total fixed costs cannot be
changed, fixed costs paid per unit may
be minimized by increasing revenue to
increase contribution to profit. (See
sample case.)
 A firm’s profitability may also be
improved by offering more
services/products for sale, as long as
the additional variable costs associated
with these additional products can be
covered by the additional sales they
generate.
Sample Case:  Inputs + technology = outputs
Peter’s Shoe Store  Inputs (Factors of Production):
 Fixed costs (FC): P5,000/week productive resources
 1st week’s sales:  Land(L) -all natural
 100 pairs of shoes resources
 Average price of P500  Labor (Lr)-all human
 Equals total sales of P50,000 resources
 Fixed cost rate:  Capital (K) -all human-
 P5,000 FC / P50,000 sales = 10% FC of made resources
sales  Outputs: finished
 P5,000 / 100 pairs sold = P50 / pair FC goods/products and services
-------------------------------------------------
 Fixed costs (FC): P5,000/week Types of Inputs
 2nd week’s sales: Fixed Inputs
 200 pairs of shoes  Inputs whose quantities do not change
 Average price of P500 regardless of output.
 Equals total sales of P100,000  In the short run, fixed inputs are
 Fixed cost rate: constant in number. In the long run,
 P5,000 FC / P100,000 sales = 5% FC of they may vary.
sales Variable Inputs
 P5,000 / 200 pairs sold = P25 / pair FC  inputs whose quantities change in
response to the firm’s desire to increase
Controlling Costs” Review or decrease output
1. What is a fixed cost? Production Function - refers to the physical
-Expenses that must be paid no matter how relationship existing between the firm’s inputs
many goods or services are offered for sale and outputs
2. What is a variable cost?  Total Product (TP) – total amount of goods
-Costs that change with the number of products produced per period
offered for sale  Marginal Product (MP) – change in the
3. How can a firm reduce its fixed cost per unit total product divided by the change in the
sold? no. of units of variable factor used;
-Increase sales additional output produced by an
4. Explain the advantage of reducing the fixed additional unit of a given input
cost per unit sold.  Average Product (AP) – total product
-Increases contribution to profit divided by the no. of units of variable
5. Explain why many gas stations have become factor used; the total amount of goods
convenience stores in recent years. produced by a firm given certain inputs
-Reduce fixed cost/unit and increase Formulas
contributions to profit  MP = TP2-TP1
6. Under what conditions will selling more I2 - I1
products not improve a firm’s profit? Where: TP = Total Product
-When the additional items sold cannot cover I = variable Input
their own variable costs  AP = TP
I
Production and the Firm
Production (Manufacturing) process of
converting inputs into outputs
 all inputs (where all inputs increase by a
constant factor).
 If output increases by that same
proportional change then there are
constant returns to scale (CRTS). If
output increases by less than that
proportional change, there are
decreasing returns to scale (DRS). If
output increases by more than that
proportion, there are increasing returns
to scale (IRS)
 Example 1: where all inputs increase by
a factor of 2, new values for output
should be:
 Twice the previous output given = a
constant return to scale (CRTS)
 Less than twice the previous output
given = a decreased return to scale
(DRS)
 More than twice the previous output
Behavior of TP, MP and AP given = an increased return to scale
(IRS)
Example 2: Fixed K, Variable L

Cost of Production Theory of Value

 The price of an object or condition is
determined by the sum of the cost of
the resources that went into making it.
The cost can compose any of the
factors of production (including labor,
capital, or land) and taxation.
 The theory makes the most sense under
assumptions of constant returns to
Total Product (TP)
scale and the existence of just one non- 100
produced factor of production. These Total
are the assumptions of the so-called Product
0 (TP)
non-substitution theorem. Under these 1 2 3 4 5
assumptions, the long run price of a
commodity is equal to the sum of the
cost of the inputs into that commodity,
including interest charges.
 Returns to scale- changes in output
subsequent to a proportional change in
20 Test Your Understanding (1 /4 yellow paper):
The following is a production schedule of a
Average
10 certain firm. Fill the missing values for Average
Product
(AP) Product (AP) and Marginal Product (MP)
0
1 2 3 4 5
Law of Diminishing Returns
 As a firm uses more of the same variable
input while other inputs are constant, the
additional productivity of the additional
variable input will eventually diminish.
 If the firm increases its variable inputs, it
should likewise increase its fixed inputs to
avoid reaching eventually the 3rd stage of At which labor input level should the firm
production. produce? Explain
 If increasing inputs (V) are applied to a
Test Your Understanding (1 /4 yellow paper):
fixed input (F), a point will be reached
where each additional input (V) yields less The following is a production schedule of a
and less to the total output. certain firm. Fill the missing values for Average
 Diminishing returns mean increasing Product (AP) and Marginal Product (MP)
costs.
 The point of output in which MP
reaches a maximum is the point of
diminishing marginal productivity.
 Production implications:
 Which output level maximizes returns?
 How to avoid diminishing returns in
the short run?
 For average output or product (AP) to
At which labor input level should the firm
increase with increases in a variable input,
produce? At 2 laborers, where MP is highest
the marginal product (MP) must always be
and MP > AP.
more than the average product (MP) or
(MP > AP). At this level the firm is
maximizing its returns per unit of variable
input. Once MP starts falling below AP,
any additional variable input will only incur
diminishing returns (increasing costs) for
the firm.
Example 2: Fixed K, Variable L