1.What three decisions are made by profit maximizing firms?

 How much output to supply (quantity of product)

 How to produce that output (which production technique/technology to use)
 How much of each input to demand

2.Differentiate profits from economic costs.

 Profit is the difference between total revenue and total cost while
 Economic costs include the opportunity cost of every input.

3.What is the most important opportunity cost included in economic costs?

 The most important opportunity 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.

4.Differentiate long run and short run decisions made by firms.

 Long run That period of time for which there are no fixed factors of production: Firms can
increase or decrease the scale of operation, and new firms can enter and existing firms can exit
the industry.
 short run The period of time for which two conditions hold: The firm is operating under a fixed
scale (fixed factor) of production, and firms can neither enter nor exit an industry

5.Differentiate production process from production function; marginal product and the law of diminishing
returns; fixed costs and variable costs.

 Production process- Production is the process through which inputs are combined and
transformed into outputs.
 The relationship between inputs and outputs—that is, the production technology—expressed
numerically or mathematically is called a production function (or total product function)

 Marginal product is the additional output that can be produced by hiring one more unit of a
specific input, holding all other inputs constant.
 The law of diminishing returns states that after a certain point, when additional units of a
variable input are added to fixed inputs (in this case, the building and grill), the marginal product
of the variable input (in this case, labor) declines.

 Fixed costs do not change when output changes. fixed cost Any cost that does not depend on
the firms’ level of output. These costs are incurred even if the firm is producing nothing. There
are no fixed costs in the long run
 Variable cost A cost that depends on the level of production chosen.

6.How does the firm goes about determining how much output to produce?

We know that firms make three basic choices: how much product or output to produce or supply, how
to produce that output, and how much of each input to demand to produce what they intend to supply.
We assume that these choices are made to maximize profits. Profits are equal to the difference between
a firm’s revenue from the sale of its product and the costs of producing that product: profit = total
revenue – total cost.

One of the problems of public provision is that it leads to public dissatisfaction. We can choose any
quantity of private goods that we want, or we can walk away without buying any. When it comes to
public goods such as national defense, the government must choose one and only one kind and quantity
of (collective) output to produce.