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Unit 2 — The Firm

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To explain the concept of the production function, and to describe how firms can minimize their costs of production by utilizing an optimal combination of inputs and scale of operation.


  1. The relationship between the rate of output of a commodity and the rate at which inputs are used is called the production function.

    1. An “input” is a factor, such as labor, machinery, or land, that contributes to production.
    2. A production function “embodies” a given technology; a change in technology changes the relationship between inputs and output.
    3. If a percentage increase in all inputs results in an increase in output greater than the percentage increase in inputs, the production process has economies of scale.
  2. Some inputs can be changed more easily than others in response to a change in demand. Those inputs (such as labor, raw materials, or energy) are called variable inputs, and inputs which can only change in the long run (such as a factory) are called fixed inputs.
  3. If the successive additions to output lessen as more and more of an input is added (while technology and the quantity of other inputs are held constant), the input is subject to diminishing marginal returns.
  4. To minimize its costs, a firm must choose a combination of inputs to meet the following condition: the marginal product of a dollar’s worth of any one input must equal the marginal product of a dollar’s worth of any other input used.

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Meet the Series Experts

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Michael Aslett

Michael Aslett

Partner/Publisher at PrintPOD Inc., using the Internet and print-on-demand distribution to further the development of desktop publishing.

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Raymond Burnett, Jr.

Raymond Burnett, Jr.

Retired Studebaker executive and a member of the Board of Trustees of the Studebaker National Museum.

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Jackie Flamm

Jackie Flamm

Partner/Publisher at PrintPOD, Inc., developing products for worldwide delivery over the Internet and in print.

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Study Tools



Use this web-based calculator to aid in your studies.


  1. Which of the following statements is MOST accurate: The bulk of the nation’s productive capacity is controlled by...

    just a few hundred of our largest firms.

  2. The assumption that firms generally attempt to maximize profits is...

    pretty much true, though it’s an oversimplification.

  3. In economic terms, current technology sets limits on the...

    total possible production achievable in a given time period.

  4. Studebaker Automobiles manufactured three styles of passenger cars and two models of trucks. During a given month in the life of Studebaker, which of the following would MOST LIKELY be classified as a fixed input?

    This would be the input most difficult to change over a short period of time. The last option is a product, not an input.

  5. Whether an input is considered variable or fixed depends MAINLY on...

    the length of time under consideration.

  6. If the marginal product of a man-year of labor is 50 units of output, and the price of labor is $2,500 per man-year, then the marginal product of a dollar’s worth of labor is...

    .02 units of output.



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