Understanding Business Performance, Production, and Profit Theories

Reverse Engineering as a Source of Knowledge and New Technology

Working Backwards: Take a product produced by a competitor and devise a method of producing a similar product.

Result: A slightly different product and a slightly different production function.

Profit Theories for Describing Business Performance (e.g., Amazon)

Monopoly Theory of Economic Profits

• Some firms are sheltered from competition by high entry barriers.
• Sources of protection: economies of scale, high capital requirements, patents, monopoly over inputs, government protection (e.g., import prevention).
• Monopoly profits can arise because of luck or happenstance (being in the right industry at the right time).

Innovation Theory of Economic Profits

• Profits arise following successful invention or modernization.
• Product or process innovations.
• Profits that are due to innovation are susceptible to the onslaught of competition from new and established competitors.

Compensatory Theory of Economic Profits or Profit Theory Based on Managerial Efficiency

• Firms that operate at the industry's average level of efficiency receive normal rates of return.
• Above-normal rates of return reward firms for extraordinary success in meeting customer needs, maintaining efficient operations, etc.
• Managers find ways to organize, recombine, and coordinate resources, take risks, use skills and knowledge to create new value and reduce costs.

Corporate results can often be described by using a multitude of theories at any given moment or in the course of corporate development.

Stages of Production for Labor

In which stage should an efficient manager produce and why?

Production range divided into 3 stages:

1. Stage 1: From the origin to APL max
2. Stage 2: From APL max to MPL = 0
3. Stage 3: MPL < 0 (Variable inputs are over-utilized)

Managers should produce in the 2nd stage of production because MPL (Marginal Product of Labor) and MPK (Marginal Product of Capital) are positive but declining.

Determining the Optimal Number of Workers

In order to determine how many workers to hire, a manager should consider the weekly wage and determine:

• Number of employees
• Price of output
• Marginal Product of Labor (MPL)
• Value Marginal Product of Labor
• Unit Cost of Labor (wage)