Assignment 2

Business Economics -- Neil Harris

Chapter 3: Producing for profit (Summary)

There are some highlighted points from this chapter:

● Examining the cost of production

● Studying the impact of long term
● Analysing the revenue of a business
● Calculating profits
● Using marginal analysis to determine the optimum level of output

Examining the cost of production

There are two kinds of inputs in the production: fixed and variable input. The use of variable
inputs generates variable costs. But, the amount of fixed factors used cannot be changed in the
short term and hence their costs will also be fixed (generating fixed cost). Other than fixed and
variable costs, average and marginal costs are also introduced. Average cost is obtained by
dividing the total cost by the quantity of output produced. On the other hand, marginal cost
measures the additional cost every one output adds to the total cost. By comparing marginal cost
against the price it receives for the last or marginal unit it produces, a business can decide
whether it is economically worthwhile producing that marginal unit. The discussion on marginal
cost also includes the law of diminishing return that a business needs to consider when it decides
the quantity of goods they want to produce.

Studying the impact of long term

In the long term, all inputs, variable and fixed, can be altered, allowing a business to gain more
profit by considering their economies of scale. If the business were to double all its inputs and
output were to more than double, it would be experiencing increasing returns to scale. Costs per
unit of output should, therefore, also fall, i.e. the business achieves economies of scale (also
called scale economies). The assumption underlying economies of scale is that all of the units
which are mass-produced can be sold. If not, producers need to estimate demand accurately.To
achieve this, producers rely on flexible specialisation which enables them to secure economies of
scope.

Analysing the revenue of a business

There are two kinds of revenue being discussed in this part: average and marginal revenue.
Average revenue is the total revenue earned from selling the product averaged out over all the
units sold. Marginal revenue is the revenue earned from the last unit of the product sold. Unlike
the discussion about cost, with revenue no distinction is made between short and long runs.

Calculating profits

Profit has been defined as the excess of revenue over costs incurred by a business. There are
three kinds of profits discussed: normal, supernormal, and monopoly profits. Normal profit
occurs when the industry is in equilibrium (a business is sufficient to keep the existing
businesses in that industry). Supernormal profits may be defined as the return a business could
secure over and above the return it could obtain if it loaned its money elsewhere at the prevailing
market interest rate. Monopoly profit is essentially the same as supernormal profit. But, whereas
supernormal profits are essentially short term, which in time may well be competed away,
monopoly profits, also confusingly called abnormal or even supernormal profits, are long term.

Using marginal analysis to determine the optimum level of output

To create the optimum level of output, a business should set its production to equalize marginal
cost and marginal revenue (MR=MC). On that level, a business will gain the highest profit they
can get from their respective industry. This is widely known as the equation for profit
maximization, one of the targets a business might pursue in its operation.