5 Production
The discussion thus far has focused primarily on the demand side of the market. We have seen, for example, that a firm’s total revenue will depend, in part, on the selling price of the product, which is determined by the interaction of consumer and producer behavior in the market. We have also investigated the conditions under which a firm might increase its revenues by changing the selling price of its product. In spite of all that has thus far been accomplished, we have yet to examine the conditions under which firms produce the goods and services that are demanded by consumers, and perhaps more importantly from the perspective of senior management, the associated costs of production. If we are to investigate more closely the first-order and second-order conditions for a firm to maximize its profits, we must understand not only the revenue component of the profit equation, but the cost component as well. In this chapter we will examine the general problem of transforming productive resources in goods and services for sale in the market.
THE ROLE OF THE FIRM The firm is an organizational activity that transforms factors of production, or productive inputs, into outputs of goods and services. Economics itself is the study of how society chooses to satisfy virtually unlimited human wants subject to scarce productive resources. In fact, this economic problem can be viewed as a constrained optimization problem in which the objective is to maximize some index of human happiness, which is assumed to be 195
