BUSINESS ECONOMICS

UNIT III

PRODUCTION AND COSTS

Introduction

Production takes place in firms. A firm is an independently administered business unit. In

practice, there are different types of firms, known as sole traders, partnerships etc.

Industry- the three classes of production

Production is divided into three categories

a) Primary production
The producers of natural goods such as farmers, oil drillers, copper miners etc, are all
engaged in primary production.

b) Secondary production
The producers of sophisticated goods, manufactured goods such as carpenters, tailors, car
manufacturers, are in secondary production.

c) Tertiary
These are providers of services like bankers, retailers, stockbrokers, accountants, teachers,
doctors and entertainers.

Specialization happens when one individual, region or country concentrates in making one good.

Division of Labour

The division of labour is a particular type of specialization where the production of a good is
broken up into many separate tasks each performed by one person. An early economist, Adam
Smith, suggested that without any division of labour and specialization, one worker could
produce only ten pins in one day. However, in a pin factory where each worker performs only
one task, ten workers using the division of labour principle, could produce a daily total of 48 000
pins. Output per person (productivity) can rise from 10 to 4800 when the division of labour
principle was used.

Advantages of the division of labour

The division of labour raises output, thereby reducing costs per unit, for the following reasons:
- Workers become more practiced at the task
- Workers can be trained more precisely for the task
- Specialization enables more efficient organization of production with a series of distinct
Tasks

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Disadvantages of the Division of Labour
Eventually the division of labour may reduce productivity and increase unit costs of the
following reasons:
- Continually repeating a task may become monotonous and boring
- Workers begin to take less pride in their work
- If one machine breaks down then the entire factory stops.
- Some workers receive a very narrow training and may not be able to find alternative
jobs.
- Mass produced goods lack variety.

Limits to the Division of labour

- Mass production requires mass demand.
- The transport system must be good enough to reach a large number of consumers
(mass market)
- Barter is the direct exchange of goods for other goods. Each worker creates only part of
the finished goods; -therefore the division of labour cannot be used in a barter society.

COSTS OF PRODUCTION
It is important to first divide the costs of production into time period of short run and long run
costs, depending on variable or fixed factors of production.

The short run is defined as a period when at least one factor of production is in fixed supply, a
combination of both variable and fixed factors. The short run is the time period that is too brief
for a firm to alter its plant capacity. The plant size is fixed in the short run. Short run costs,
then, are the wages, raw materials, etc., used for production in a fixed plant.

A firm will undertake production in the short run, if the price at which their product is sold is at
least equal to the average variable cost of production. Therefore, a firm will continue in business
in the short run as long as it is able to cover the variable costs of production.

The long run is a period when all factors of production can be varied. All the factors of
production are considered to be variable. The long run is a time period long enough for a firm to
change the quantities of all resources employed, including the plant size. Long run costs are all
costs, including the cost of varying the size of the production plant.

Total Costs
The amount spent of producing a given amount of a good by a firm is called total cost, TC, and is
found by adding together variable and fixed costs.

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Variable Costs
Variable costs, VC, depend on how many (the output) goods are being made. If just one more
unit is made then total variable costs rise. Variables costs are costs that vary with output.
Examples include the following:-
- Wages paid to casual workers
- The cost of buying raw materials and components.
- The cost of electricity and charcoal.

Fixed Costs
Fixed costs, FC, are independent of output. Fixed costs have to be paid out even if the factory
stops production. Fixed costs are costs that do not vary with output. Examples include the
following:
- Monthly salaries paid to managers
- Rent paid for the use of premises
- Depreciation, that is money put aside to replace worn-out machines and vehicles
sometime in the future

The short run cost schedule of an individual firm shows the behaviour of costs when output is
varied. Table 1 below presents the cost structure of a hypothetical firm, to illustrate the general
principles covered under 4.1, 4.2 and 4.3, total costs remain the same at different levels of
output. The total costs are made up of fixed and variable costs. The output and the costs are in
thousand units and thousands of kwacha respectively.

Output Total fixed Total variable Total Costs

units costs costs

0 50 0 50
1 50 50 100
2 50 90 140
3 50 120 170
4 50 160 210
5 50 210 260
6 50 270 320
7 50 340 390
8 50 420 470
9 50 510 560
10 50 610 660

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Average cost, AC or average total cost (ATC) is the cost of producing one item, it is
sometimes called per unit cost. It is calculated by dividing total costs by total output
(ATC = TC/Q).

Note: ATC also equals AFC + AVC.

Marginal cost, MC is the cost of producing one extra unit of output, and is calculated by
dividing the change in total costs by the change in output. Marginal decisions are very important
in determining profit levels. Marginal revenue and marginal cost are compared.

Average fixed cost is the total fixed cost divided by the level of output (TFC/Q). It will decline
as output rises.

Average variable cost is the total variable cost divided by the level of output

(AVC = TVC/Q).

Note that in Economics, for practical purposes, the average cost data is used more than the total
aggregate figures. The table 2 below presents the cost structure of a hypothetical firm, a
continuation of table 1 above. It illustrates the general principles covered under 4.4,4.5, 4.6 and
4.7

Output Average variable Average fixed Average total Marginal

units costs costs costs costs
0 - - - -
1 50 50 100 50
2 45 25 70 40

3 40 16.6 56.6 30

4 40 12.5 52.5 40

5 42 10 52 50

6 45 8.3 53.3 60

7 48.6 7.1 55.7 70

8 52.5 6.3 58.8 80

9 56.6 5.5 62.1 90

10 61 5 66 100

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After plotting the above information, the following diagrams are obtained, where 1 is the
marginal cost curve, 2 is the average total cost curve, 3 is the average variable cost curve and 4 is
the average fixed cost curve respectively.

Explicit costs are those costs that are clearly stated and recorded.

Implicit costs are those costs that are implied, unstated but understood as a necessary component
in the economist’s view. These are opportunity costs, benefits forgone by not using the factor of
production in the next most profitable way. This is important because it explains the difference
in the calculation of profit between the Accountant and the Economist.

Accounting profits are sales revenue minus explicit costs of a business.

Economic profits consist of sales revenue minus explicit and implicit costs!

For example, assuming that Mabvuto runs a business and sells goods worth K100, 000, the cost
of sales is K45, 000. If the premises used for the business could be put to alternative use, it can
earn a rent of K10, 000. The capital invested in the business could have earned K15, 000 in
interest if deposited in a bank. Suppose Mabvuto was employed elsewhere, he would have been
earning an income of K25, 000. The accounting gross profit and the Economic profit or loss
earned is as follows:

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Accounting profit K K

Sales 10,000
Less cost of sales 45,000
___
Gross Profit 55,000

Economic profit

Sales 10,000
Less cost of sales 45,000
___
Gross Profit 55,000

Less opportunity costs

Rent 10,000
Interest 15,000
Salary 25,000
Opportunity costs total 50,000

Economic profit 5,000

SHAPE OF THE SHORT RUN COST CURVES

Short run production reflects the law of diminishing returns that states, “as successive units of a
variable resource are added to a fixed resource, beyond some point the product attributable to
each additional resource unit will decline”.

The law of diminishing returns is explained as an essential concept for understanding average
and marginal cost curves. The general shape of each cost curve is a “U”.

The AFC and the AVC both influence the AC. As output increases, both the AVC and the ATC
curves will first slope downward and then slope upward due to diminishing returns. The same
volume of fixed costs are divided by increasing levels of output, therefore the AFC is constantly
decreasing.

Marginal cost is a reflection of marginal product and diminishing returns. When diminishing
returns begin, the marginal cost will begin its rise. The marginal cost is related to AVC and ATC.
It is the variable cost component in the total cost that changes as output levels increase.

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These average costs will fall as long as the marginal cost is less than either average cost. As
soon as the marginal cost rises above the average, the average will begin to rise. The relationship
between AC and MC is summarised as

 At low levels of output, the MC curve lies below the AVC and the ATC curves
These curves will slope downward

 At higher levels of output, the MC curve will rise above the AVC and the ATC curves
These curves will slope upward

 As output increases, the average curves will first slope downward and then slope upward
Will have a “U” shape

 The MC curve will intersect the minimum points of the AVC and the ATC curves.

FACTOR MARKETS
The four factors of production explained in chapter one, land, labour, capital and enterprise are
used by firms in any productive service that people perform. Each factor receives a reward.

Labour performs work and is paid by wages and salaries.

Capital is a man made resource, and the owners of capital receive interest.
Land consists of natural resources for which rent is paid.
Entrepreneurs establish business firms and receive profit.

The important question is ‘what determines the rate at which each factor is paid?’ In other words,
what determines the level of wages and salaries, rent, interest and profit? Factor rewards are

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prices paid for each factor of production, and just like any price, it is determined by the market
forces of demand and supply.

The demand for factors of production differs from the demand for consumer goods and services.
The demand for factors is said to be a derived demand, the demand is derived from the demand
for the final product, which they help to produce. Factors of production are not demanded for
their own sake, but they are demanded because firms want to produce consumer goods and
services.

The market demand curve for a factor resembles that of a consumer good, a typical demand
curve slopes downwards from left to right. The higher the ‘price’ of a factor, the lower the
demand for it, and vice versa.

The demand for factors of production also introduces the diminishing marginal productivity
theory that is each additional unit of any factor employed tends to add progressively less to total
output (other factors being held constant).

An individual firm will increase its employment of any factor as long as the value of the extra
output achieved exceeds the additional cost involved.

The supply of a factor represents the different quantities that are offered at various possible
‘prices’. For example the higher the wage rate, the higher the supply of labour, and vice versa.
Therefore, a typical supply curve for a factor resembles that of a consumer good, it slopes
upward from left to right.

A change in factor ‘prices’, such as wage rates, maybe due to changes in the demand and supply
conditions of labour, just like in the product market.

Note that the above is generalized, in practice, there are other factors that should be considered in
the factor market, including elasticity.

LONG RUN COSTS

Introduction
The long run is when all factors of production are variable, and as such all the costs must be
covered. The firm is assumed to be a profit maximiser. It can plan ahead on long run
improvements, which involve changing factors of production that are currently fixed. Therefore
if a firm is to continue in business in the long run, the price must at least equal average total cost
of production.

In the long run, firms have combinations of factors of production that result in low average costs.
The factors that cause average costs to decline in the long run as output increases are known as
economies of large-scale production, commonly known as economies of scale.

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The shape of the long run average cost (LRAC) curve however, depends on whether

- Output increases more in proportion to inputs, when there are economies of scale and
the LRAC decline to show increasing returns to scale.

- Output increase in the same proportion as inputs indicating constant returns to scale.

- The arrow is pointing to the minimum efficiency scale (MES), which is that level
of output on the LRAC curve at which average costs first reach their minimum
point. At output levels below this point, the firm will experience higher average
costs, otherwise, the LRAC remain unchanged at whatever the level of output, and
the curve is flat.
- Output increases less than in proportion to inputs, due to diseconomies of scale, LRAC
increases as output increases. As output continues to increase, most firms reach a point
where bigness begins to cause problems. When LRAC rise more than in proportion to
output, there are diseconomies of scale, and the curve slopes upward.

The behaviour of LRAC can be summarised as:

- Economies of scale (decreasing LRAC) at low levels of output

- Constant returns to scale (constant LRAC) at intermediate levels of output
- Diseconomies of scale (increasing LRAC) at high levels of output

Therefore, the LRAC curves are typically “U” shaped as shown below

Cost

Output

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 Economies Constant Diseconomies

of scale returns of scale

to scale

ECONOMIES OF SCALE
These indicate that as the output or plant size increases, the average costs per unit decreases or
falls, they are reductions in long run average total costs achieved when the whole scale of
production is expanded.

Not all the factors are expanded proportionately with output. Average costs fall as output is
expanded, but not all fixed factors of production need to be increased in line with output. This
reduction in the long run average costs is due to economies of scale.

Economies of scale only occur in the long run, as they are associated with the alteration of some
or all of the firm’s fixed factors. The economies of scale are either internal (within the firm) or
external (originating outside the firm).

INTERNAL ECONOMIES
These are advantage that accrue within an organization because of large-scale production which
a firm a can plan to achieve directly by increasing the size of its output. The benefits accrue to
the individual firm, some of them include the following:

Financial Economies
When raising finance large firms, since they are household names, can easily borrow money
from commercial banks and negotiate for lower interest rates. In addition, they have more
advantages because they offer better security to bankers than a briefcase businessperson. Large
firms can also raise new capital at a lower cost through the issue of shares, company bonds or
commercial paper.Therefore, it is generally accepted that larger firms can raise funds more easily
and cheaply than small firms.
Technical Economies
The advantages of division of labour and specialization can be achieved, as the plant grows in
size and output increases, it becomes more possible for labour to undertake more specialized
activities. This increases efficiency and reduces costs per unit.

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The firm can also buy specialized sophisticated machinery, this is utilized more efficiently if
operation is on a large scale. There is greater use of advanced machinery. Some machines are
worth using beyond a minimum level of output, which maybe beyond the capacity of a small
firm. For example the use of combine harvesters by commercial farmers, compared to its use by
small subsistence farmers with less than an acre of land.

More resources are devoted to research and development because resources are borne over more
units of output in large firms, this leads to further technical improvements, more cost reductions.

Managerial Economies
The division of labour can be introduced into the task of management. The function of
management is divided into production, sales, finance etc. A large firm can afford to hire
specialists in different fields, which is an efficient use of labour resources.
Commercial or Trading Economies
The large firm achieves economies both in buying raw materials and other inputs, as well as in
selling finished products.
Favourable terms are granted to a large firm since it buys in bulk and may get discounts. It can
afford to employ specialist buyers.

The cost per unit of advertising on television may be expensive for a small firm, but far lower for
a firm with a high output. Therefore, there are reduced costs per unit in advertising, sales
promotion and distribution.

Welfare
Large firms are in a position to increase production by improving the condition of service of their
employees through the provision of facilities such as transport, clinics, sport and other recreation
facilities.

EXTERNAL ECONOMIES
External economies are advantages of an increased scale possible to all firms in an industry.
They are influenced by the growth of the industry as a whole.

External economies occur when an industry is concentrated in one area, and the local economy
evolves around the industry. The industry is supplied with skilled labour force, specialist
suppliers etc. It is also associated with knowledge, new inventions and the discovery of new
markets.

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External economies are made outside the firm as a result of its location and occur when:

 A local skilled labour force is available

 Specialist local back up firms can supply raw materials, component parts or services.
They supply to a large market and achieve their own economies of scale, which are
passed on through lower input prices.
 An area has a good transport network
 An area has an excellent reputation for producing a particular good
 Firms in the industry may find a joint enterprise and share their research and
development facilities, to lower the overhead costs.
 As the industry grows in size, different firms within it specialize in different processes.
A good example of external economies of scale in Zambian is copper mining in the
copper belt province. A number of firms provide information, labour, machinery or
component parts that are required by the copper mining companies.

DISECONOMIES OF SCALE
These are problems of growth, unlimited expansion of scale of output may not necessarily result
in ever-decreasing costs per unit. There may be a point beyond which average costs begin to rise
again.

Cost

Output

Diseconomies of scale can be categorized in the same way as economies of scale.

INTERNAL DISECONOMIES OF SCALE

 Managerial diseconomies occur, as large firms are difficult to manage in relation to

effective control and coordination. The disadvantages of the division of labour,
increasing bureaucracy as the firm becomes too large and loss of control as management
becomes distanced from the shop floor.

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  Labour relations affected, workers cease to feel that they belong: moral and motivation
fall.
 As the firm increases in size management may become complacent since it is less
vulnerable to competition from other firms. These complacency leads to inefficiency
termed “X” inefficiency.
 Decisions are not taken quickly
 Technical diseconomies occur, as the technical size of the plant may create large
administrative overheads.
 Trading diseconomies, which is mass standardized production verses individualism.

EXTERNAL DISECONOMIES OF SCALE

As the firm and industry grows it may be hampered by shortage of various types, for example,

- Local labour and raw materials become scarce and firms have to offer higher wages to
attract new workers or buy raw materials at high costs.

- Land, factories become scarce, and rents begin to rise. Roads become congested and so
transport costs begin to rise.

- Lack of markets for the firms’ out put.

SMALL FIRMS
It is difficult to classify firms as small or large. This generally depends on whether one is
residing in a developed or in a developing country. Generally, small firms are classified by size
relative to other firms, for example
- 25 employees or less is a small firm
- A turnover of K1 000 000 or less
- Assets like 3 vehicles or less
- A relatively small market share, and so on.

Small firms are largely found in retailing, financial and services like consultancies.

The number of small firms is high because the number of people being self-employed is growing
due to retrenchments. In addition, there is no formal sector growth to absorb the unemployed.

As the result, most governments have come up with a policy of advising and training people to
start small businesses.

Governments, mostly in developed countries, provide loans, loan guarantee schemes and
working capital as well as tax rebates.

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Small firms compete with large firms and they owe their survival to the following:-

- They can adapt to customer needs quickly.

- They offer individualized service as opposed to mass production and standardized
products.
- There is personal involvement in the business by the owner.
- Flexible approach and personal relationship with customers and employees in addition,
- In addition, some products cannot be mass-produced, like spectacles, others have only a
limited demand for example custom made items, and some require little capital, like
window cleaning.

THE LOCATION OF INDUSTRY

A company will locate its factory and offices where it can achieve minimum costs and maximum
profits.

Principle influences on the location of industries are:-

- Nearness to raw materials especially where the raw materials are heavy and
bulky.
- Accessibility to the markets
- Nearness to the power supply
- Government policy

INTEGRATION OR AMALGAMATION OF FIRMS

This may be horizontal, vertical or lateral.

Horizontal Integration
Horizontal integration occurs when firms that are producing the same type of product, and are at
the same stage of the production process, join together. An example is if Kafue Textiles acquires
or combines with Mulungushi Textiles.

The reasons for horizontal integration would be for firms to:

- Obtain economies of scale

- Increase market share
- Fight off imports
- Pool technology

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Vertical Integration
This is the amalgamation of firms engaged in different stages of production, it may be towards a
source of raw materials, known as backward vertical integration, an example is if Zambeef
acquires a cattle ranch. Alternatively, it may be near to the market known as forward vertical
integration. An example is when an oil exploration company takes over an oil marketing
company like Total or British Petroleum.

Reasons for vertical integration:

- To eliminate transaction cost of middlemen

- To increase entry barriers for new competitors
- To secure raw material supplies
- To improve distribution network

Lateral Integration
This occurs when firms increase the size of their products. Concentration on one product may
make a firm vulnerable, hence the need to diversify. A firm may be vulnerable to a change in
fashion, a ‘recession’ or a change in government policy.

Reasons for diversification:

- To minimize risks
- To make use of expertise by seeking challenging situation
- To achieve economies of scale

DISTRIBUTION OF GOODS
An individual firm in most cases is only a single link in a larger supply chain and distribution
channel. A firm’s success depends on how well it performs as well as how well its entire
distribution channel competes with competitors’ channels.

Distribution of goods refer to the methods by which producers transfer goods and services to
consumers. A variety of functions are involved in distribution, including stock management to
ensure continuous production, transporting of goods to consumers, proximity to the local market
and knowledge of that market in order to pursuer economies of scale, as well as major
promotional campaigns and the display of goods for sale.

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In setting up a channel of distribution, a producer has to take into account the following:-

 The number of potential customers, their buying habits and their geographical location.
 Product characteristics such as whether the product is perishable, and therefore speed of
delivery is essential, or whether the product is customized and has to be distributed directly
etc.
 The location, performance promotion, pricing policies and other characteristics of the
distributor.
 The channel choice of competitors, which maybe exclusive.
 The supplier’s own characteristics, for example, is the supplier a market leader, more
importantly, does the supplier have a strong financial base to operate own distribution
channel?

WHOLESALING AND RETAILING

This consists of many organizations bringing goods and services from point of production to
point of use.

Wholesaling includes all the activities involved in selling goods or services to those who are
buying for the purpose of resale or for business use.

Wholesalers stock in a range of products from competing producers to sell to retailers. Many
wholesalers specialize in particular products and perform many functions such as selling,
promoting, warehousing, transporting, financing, supplying market information, providing
management services etc.

Retailing includes all the activities involved in selling goods or services directly to households
or final consumers for their personal non-business use. Retailers are traders operating outlets.
In practice, there are different types of retailers, the majority are classified as store retailers,
while others are non-store retailers, and this number is growing at a fast rate. A good example
in Zambia is street vending.

Store retailers are further classified as:-

- Self-service, limited service or full service, depending on the amount of service

they provide.
- Speciality stores, department stores, supermarket stores, convenience stores etc,
depending on the product line sold.

- Discount stores or price retailers, this depends on the relative prices.

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- Corporate chains, retail cooperatives, merchandising conglomerates etc.,
depending on whether retailers have banded together in corporate and
contractual retail organizations.

DISTRIBUTION CHANNELS
Producers sometimes distribute goods directly to consumers, but in most cases, the distribution
is done indirectly through a wide range of intermediaries between the original producer and the
ultimate consumer. Each layer of intermediary that performs some work in bringing the
product and its ownership closer to the final consumer is a channel level. Both the producer and
the consumer perform some work and therefore, they are part of every channel as shown below.

NUMBER OF INTERMEDIARIES/CHANNEL LEVELS

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Zero One Two Three

Producers Producer Producers Producers

Agent

Wholesaler

Wholesaler

Retailer

Retailer Retailer

Consumer Consumer Consumer Consumer

Direct distribution

channel Indirect distribution channels

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Note that in practice, there are other intermediaries, such as-

- Distributors and dealers who contract to buy a producer’s goods and sell them to
customers. Distributors often promote the products and offer after sales service.
- Agents sell goods on behalf of suppliers and earn a commission on their sales.
- Franchisees are independent organizations, who trade under the name of a parent
organization in exchange for an initial fee and a share of the sales revenue.

However, the two major channels of distribution are the retailers and the wholesalers.

TOTAL REVENUE (TR)

This is the money the firm gets back from selling goods and is found by multiplying the number
sold, Q, by the selling price, P.
TR = (Q x P)

Average revenue AR, is the amount received from selling one item and equals the selling price
of the good, the price per unit.

AR = TR

Marginal Revenue MR is the change in total revenue from the sale of one more unit of output.

MR = ∆TR

∆Q

Profit

Firms are profit maximisers. Profit is calculated as the difference between total revenue and total
costs.

P = TR - TC

It is private costs not social costs that are taken into account. The private cost to a motorist of
driving from Chipata to Lusaka is the cost of petrol and oil and the wear and tear on the car.

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However, other people have to put up with the externalities of the journey, for instance the noise,
smell, pollution and traffic congestion the motorist helps to cause along the way.

Total revenue and total cost both vary with output. Total revenue starts from zero and increases
gradually, then flattens out as output and sales increase.

Total costs do not start from zero due to the element of fixed costs, they accelerate and become
steep as output increases.

Profits are at a maximum where the vertical distance is greatest, as shown in the diagram below.

Revenue TC

and

Costs

TR

Quantity

Profit maximising position

If MC is lower than MR, then profit increases by making and selling one more unit of output.
However, if MC is higher than MR, profits fall if one more unit is made or sold.
If MC is equal to MR, then the profit maximizing position has been reached, as shown below.

Profits are maximized where MC = MR.

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 AN IMPERFECT MARKET A PERFECT MARKET

MC Revenue MC

Revenue MR and MR

and Costs

Costs

Quantity Quantity

UNIT SUMMARY

There are various types of organizations in mixed Economic systems. Business organizations are
categorized as sole traders, partnerships, limited companies and cooperatives.

The economy can be divided into primary, secondary and tertiary sectors.

A firm’s output decisions can be examined both in the short run, when at least one factor of
production is in fixed supply, or in the long run, when all factors of production are considered to
be variable.

A firm’s total cost of production is made up of fixed and variable costs.

Average fixed cost declines as output increases, average variable costs initially falls as output
increases, then after a certain point, when diminishing returns set, the average variable costs
begin to rise.

When average fixed cost and average variable cost are added, the resulting average total costs
fall, and then rises as output increases.

The marginal costs also falls briefly, then rises, cutting the average costs at their minimum
points.

Economic costs are different from accounting costs. Economic costs include the opportunity
costs of factors of production that are used.

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The factor market is similar to the market for goods and services. The demand for factors of
production is derived from the demand for the final goods and services, which that factor helps
to produce.

As some firms expand, whether by mergers, diversification or take-overs, the firms enjoy
economies of scale, whereby there is a reduction in average total costs as output expands.

Economies of scale are of two types, internal and external.

Unfortunately, the growth is sometimes accompanied by problems of diseconomies of scale,

which are also of two types, internal and external diseconomies of scale. This causes the average
total cost to rise as output increases.

Small-scale production is equally important and continues to grow partly due to some limitations
on large-scale production.

Producers have to deliver goods and services to customers, this maybe done directly or indirectly
using a wide range of intermediaries such as agents, franchisees, dealers etc. However, the two
major channels of distribution are the wholesalers and the retailers.

Firms expand because of the desire to make more profits, enjoy the economies of scale etc. One
form of expansion is through amalgamation of firms, and this maybe vertical, horizontal or
lateral integration.

In Economics, the stated objective of firms is profit maximization, and it is attained where MR =
MC.
Summary of equations

TC = VC + FC
VC = TC – FC
FC = TC – VC
AC = TC/Q
TR = P x Q
AR = TR/Q
MC = ∆TC/∆Q
MR = ∆TR/∆Q
Social Cost = Private costs + Externalities = Social Cost
(Cost to individual) + (Cost to other people) = (Cost to everyone)

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