Originally written at Mba-tutorials
Now we have demand side of the market and the supply side. From the word supply we do understand very easily that we are going to discuss about the or examine the behavior of Producers. We will see how firms can produce efficiently and how their costs change with the change in their input prices and the level of output.
This all is a part of Theory of a firm which describes how a firm makes cost minimizing production decision and how the firm’s resulting cost varies with its output.
Consider some of the issues or problems faced by the company. For example
- how much labor should be used by an automobile company?
- If it wants to increase production , should it hire more labor, construct new plants or both?
- does it make sense to produce more different product than the existing one ?
- how these costs effects the level of production or output ? etc.
Let us break down the production decision of a firm into three steps :
- Production Technology
- Consumer constraints
- Input Choices
The requirement of a practical way in describing the how the INPUTS (land, labour, capital) is transformed into Output (cars, tv, computer etc). Just as the buyers reaches to a certain level of satisfaction by buying different combination of goods, the firm can produce a particular level of output by having different combinations of input.
Firms in particular, must consider the prices of labor, capital and other inputs. Because just as a consumer is constrained by limited budget so does the producer has to be concerned about the cost of its production.
The firm must choose the amount of input to be used in the production of each unit. Again its just like a consumer takes account of the prices of different product before deciding to buy anything . So does the producer takes account of the prices of different inputs for its production. Because if the price of input increase, consequently the output or the price of final product will also increase which will lead to lower demand of that particular product.