Microeconomics Fundamentals: Demand, Production, and Cost Analysis

Understanding Economic Principles: Demand, Production, and Costs

The Concept of Demand

Individual Demand Curve

The individual demand curve represents the quantity of a good that consumers want to purchase at various prices.

Variables Affecting Demand

• Price of the good: The most direct influence.
• Consumer income: Affects purchasing power.
• Prices of other goods: Relates to substitutes and complements.
• Tastes and preferences: Subjective consumer desires.

Demand Function

The demand function specifies, for each possible price of a good, the quantity demanded by the consumer.

Effects on Demand

• Substitution Effect: Occurs when consumers switch to a relatively cheaper substitute due to a price change. (e.g., choosing dental floss over a toothbrush if the toothbrush price increases significantly).
• Income Effect: Reflects the change in consumption patterns due to a change in real income caused by a price change. (e.g., if theater tickets become more expensive, one might attend 3 times instead of 5).

Displacement of the Demand Curve

The demand curve shifts when factors other than the good's own price change, such as consumer income.

• Normal Goods: Demand increases as consumer income rises. (e.g., olive oil).
• Inferior Goods: Demand decreases as consumer income rises. (e.g., buying chicken instead of beef when income increases, assuming beef is preferred but more expensive).
• Neutral Goods: Demand is unaffected by changes in consumer income. (e.g., essential medicines).

Firm Objectives and Revenue

The Goal of the Company

Companies typically pursue multiple objectives, including:

• Maximizing profit.
• Ensuring stability and adaptation to market changes.
• Expanding commercial area or territory.
• Fulfilling social responsibility, which may involve assuming social costs and ensuring environmental compliance.

Revenue and Costs Defined

• Revenue: The total amount received from selling a product or service.
• Costs: The monetary sacrifice a company makes to acquire the inputs necessary for its production process.

The Production Process

Defining Production

The production process is defined as the method by which raw materials and other inputs (inputs) are transformed into finished goods or services (output).

Types of Inputs

• Fixed Inputs: Resources that do not vary with the amount of production in the short term. (e.g., machinery, factory buildings).
• Variable Inputs: Resources that do vary with the amount of production. (e.g., raw materials, labor).

Technology's Role

Technology plays a crucial role; new technologies often allow for greater production with the same amount of employed factors.

Production in the Short and Long Term

Short-Term Production

In the short term, at least one factor of production is fixed. To increase production, a company primarily increases its variable inputs (e.g., hiring more workers).

The production function describes the maximum amount of product that can be produced with a given set of inputs.

Law of Diminishing Returns

The Law of Diminishing Returns states that by increasing the amount of one productive factor while holding others constant, the increases in the amount of the product will eventually become smaller.

Long-Term Production

The long term is a period of time in which all factors of production can be varied. There are no fixed inputs in the long term, meaning all costs are variable.

Production Costs

Understanding Costs

Production costs represent the sacrifice a company makes to acquire the necessary inputs for producing goods and services.

Types of Production Costs

• Fixed Costs: These costs remain constant and are independent of the number of units produced. (e.g., rent for a factory, depreciation of machines, tools).
• Variable Costs: These costs depend on the level of production. As production changes, the quantities of these inputs must be modified. (e.g., in a clothing factory, as demand for trousers changes, the need for fabric, zippers, and thread will vary). Variable Cost (VC) = Quantity of Input (X) × Price of Input (P).