The Costs of Production

The economy is made up of thousands of firms that produce the goods and services you enjoy every day. General Motors produces automobiles, General Electric produces light bulbs, and General Mills produces break fast cereals. Some firms, such as these three, are large; they employ thousands of workers and have thousands of stockholders who share in the firms’ profits. Other firms, such as the local barbershop or candy store, are small; they employ only a few workers and are owned by a single person or family.

In previous chapters, we used the supply curve to summarize firms’ production decisions. According to the law of supply, firms are willing to produce and sell a greater quantity of a good when the price of the good is higher, and this response leads to a supply curve that slopes upward. For analyzing many questions, the law of supply is all you need to know about firm behavior. In this chapter and the ones that follow, we·examine firm behavior in more detail. This topic will give you a better understanding of what decisions lie behind the supply curve in a market. In addition, it will
introduce you to a part of economics called industrial organization-the study of how firms’ decisions about prices and quantities depend on the market conditions they face. The town in which you live, for instance, may have several pizzerias but only one cable television company. This raises a key question.

How does the number of firms affect the prices in a market and the efficiency of the market outcome? The field of industrial organization addresses exactly this question.Before we turn to these issues, however, we need to discuss the costs of production. All  firms, from Delta Air Lines to your local deli, incur costs as they make the goods and services that they sell. As we will see in the coming chapters, a fum’s costs are a key determinant of its production and pricing decisions. In this chapter, we define some of the variables that economists use to measure a firm’s costs, and we consider the relationships among these variables.

A word of warning: This topic is dry and technical. To be brutally honest, one might even call it boring. But this- material provides a crucial foundation for the fascinating topics that follow.

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