Business Economics: Production, Costs, Supply, and Demand

Posted on Dec 10, 2024 in Economy

Company: Definition and Elements

A company is a set of elements organized and coordinated by management to produce goods for the purpose of obtaining a profit while operating under conditions of risk. Key elements include:

  • Human Factors
  • Material Factors
  • Organization
  • Environment
  • Objectives

Company Activity Cycle

The company activity cycle involves both long-term and short-term assets and liabilities:

  • Assets
    • Long-term (Investment): Machinery, equipment, patents, etc.
    • Short-term (Current): Cash, inventory, etc.
  • Liabilities
    • Equity (Net Liabilities or Social Capital)
    • Debt Capital (Long-term and Short-term Liabilities)

Production Process

The production process can be summarized as follows:

Inputs (raw materials, energy, labor) → Production → Outputs (goods and services)

Production Function and the Law of Diminishing Returns

The production function is represented as: Q (production) = F (technology, labor, capital). Technology significantly influences the production function.

The law of diminishing returns states that as the use of a variable factor increases while other factors remain constant, the marginal and average product of the variable factor will eventually decrease.

  • Total Product (TP): The total quantity of output produced.
  • Average Product (AP): TP divided by the quantity of the variable factor (labor) used. Formula: AP = TP / L
  • Marginal Product (MP): The additional output produced by increasing the variable factor by one unit. Formula: MP = ΔTP / ΔL

Production Costs

Total Cost = Fixed Cost + Variable Cost

Fixed costs remain constant regardless of production levels, while variable costs change with the level of output.

Demand Curve

The demand curve illustrates the relationship between the price of a good or service and the quantity demanded. It is represented as:

Dx = F (Px (price of the good), Py (prices of other goods), Y (consumer income), G (tastes or preferences))

Factors affecting the demand curve:

  • Price: Movement along the demand curve.
  • Other Factors: Shift the demand curve. These include prices of other goods (substitutes and complements), consumer income (inferior, normal, and luxury goods), and tastes and preferences.

The demand curve is typically downward sloping, indicating that a higher price leads to a lower quantity demanded.

Supply Curve

The supply curve represents the relationship between the price of a good or service and the quantity supplied. It is represented as:

Sx = F (Px (price of the good), Py (prices of other goods), C (production costs), G (other factors, e.g., technology, objectives))

Factors affecting the supply curve:

  • Price: Movement along the supply curve.
  • Other Factors: Shift the supply curve. These include prices of other goods (substitutes and complements), production costs, and other factors like technology and business objectives.

The supply curve is typically upward sloping, indicating that a higher price leads to a greater quantity supplied.

Market Equilibrium: The Law of Supply and Demand

The law of supply and demand describes the mechanism that leads to market equilibrium. Equilibrium occurs when the quantity demanded equals the quantity supplied at a specific price.

  • Excess Supply: Occurs when the quantity supplied exceeds the quantity demanded at a given price, leading to unsold products.
  • Excess Demand: Occurs when the quantity demanded exceeds the quantity supplied at a given price, leading to shortages.

Shifts in the demand or supply curves, caused by factors other than price, result in a new equilibrium price and quantity.

Elasticity of Demand

Elasticity measures the responsiveness of one variable to changes in another. The elasticity of demand measures the responsiveness of quantity demanded to changes in price.

Factors influencing the elasticity of demand:

  • Type of Need: Essential goods (e.g., electricity) tend to have inelastic demand.
  • Availability of Substitutes: Goods with many substitutes (e.g., travel) tend to have more elastic demand.

Formula: Elasticity = % Change in Quantity Demanded / % Change in Price

Formula

A more vertical demand curve indicates inelastic demand, while a more horizontal curve indicates elastic demand.

Virtuous and Vicious Cycles

Vicious Cycle (Crisis of Demand):

Decreased demand → Reduced production → Fewer factors of production (less employment, less investment) → Lower income → Decreased demand (and the cycle repeats).

Vicious Cycle (Oversupply):

Oversupply → Reduced production → Lower income → Decreased demand → Oversupply (and the cycle repeats).

Virtuous Cycle:

Increased demand → Increased production → More factors of production (more employment, more investment) → Higher income → Increased demand (and the cycle repeats).