What is a Firm? What is Production? What is Cost of Production?
In previous sessions, we discussed in detail regarding the behavior of a firm. A firm is an entity which undertakes the process of production. Production is a process by which a firm transforms inputs into output. Inputs are the factors of production used in the process of production. The output is the final product, can be either goods or services which are then used by either consumer directly or by other firms as an intermediate for carrying their own production process.
The firm incurs several costs while undertaking the process of production which are associated mainly with the inputs or factors of production used in the process of transformation. These costs are known as Costs of Production. The firm on the other hand earns revenue on selling the output which is termed as Revenue. And the excess of Revenue over the costs of production is known as Profit for the firm.
What is Production Function?
Production Function defines relationship between the inputs used and the output produced by a firm. For given amount and combination of input, the production function gives the maximum amount of output that can be produced by a firm. The production function while giving the maximum output, assumes that the firm is using the inputs or resources or factors of production in the most efficient manner. So production function assumes most efficient use of resources. And the efficient use of resources depends on the technological know-how and level. If the technological level improves so does the maximum output level given by production function. So production function defines the relationship between inputs and output while considering two assumptions, one being efficient use of resources and other being a given constant technological level.
What is Cost Function?
Now as we discussed the Production Function, it talked about the maximum output for a given amount and combination input. And thus it assumes the most efficient use of inputs.
The same maximum output as given by the production function can be attained with different combinations of inputs or factors of production used by a firm. The set of all possible combinations of inputs which all leads to the same maximum possible output given by a production function is known as Isoquant. The graphical representation of the set of all combination of input giving the same maximum possible output is referred to as the Isoquant Curve.
Now for simplicity we will assume that there are two factors of production or input used by a firm in the process of production which are Labor (L) and Capital (K). The following table shows the level of maximum output that can be produced with different combinations of the given inputs i.e., Labor (L) and Capital (K).
Here in the above table, with different units of Labor (L) and Capital (K) used by a firm, the corresponding level of maximum output that can be produced by the firm is mentioned.
In previous sessions, we discussed in detail regarding the behavior of a firm. A firm is an entity which undertakes the process of production. Production is a process by which a firm transforms inputs into output. Inputs are the factors of production used in the process of production. The output is the final product, can be either goods or services which are then used by either consumer directly or by other firms as an intermediate for carrying their own production process.
The firm incurs several costs while undertaking the process of production which are associated mainly with the inputs or factors of production used in the process of transformation. These costs are known as Costs of Production. The firm on the other hand earns revenue on selling the output which is termed as Revenue. And the excess of Revenue over the costs of production is known as Profit for the firm.
What is Production Function?
Production Function defines relationship between the inputs used and the output produced by a firm. For given amount and combination of input, the production function gives the maximum amount of output that can be produced by a firm. The production function while giving the maximum output, assumes that the firm is using the inputs or resources or factors of production in the most efficient manner. So production function assumes most efficient use of resources. And the efficient use of resources depends on the technological know-how and level. If the technological level improves so does the maximum output level given by production function. So production function defines the relationship between inputs and output while considering two assumptions, one being efficient use of resources and other being a given constant technological level.
What is Cost Function?
Now as we discussed the Production Function, it talked about the maximum output for a given amount and combination input. And thus it assumes the most efficient use of inputs.
The same maximum output as given by the production function can be attained with different combinations of inputs or factors of production used by a firm. The set of all possible combinations of inputs which all leads to the same maximum possible output given by a production function is known as Isoquant. The graphical representation of the set of all combination of input giving the same maximum possible output is referred to as the Isoquant Curve.
Now for simplicity we will assume that there are two factors of production or input used by a firm in the process of production which are Labor (L) and Capital (K). The following table shows the level of maximum output that can be produced with different combinations of the given inputs i.e., Labor (L) and Capital (K).
Here in the above table, with different units of Labor (L) and Capital (K) used by a firm, the corresponding level of maximum output that can be produced by the firm is mentioned.
Let us take a scenario where the output the firm is targeting to achieve is 100 units. Now the output of 100 units can be derived by the firm using several possible combinations of the inputs used i.e., here Labor (L) and Capital (K). The different combinations of Labor (L) and Capital (K) which gives the desired output of 100 units are (6L, 3K), (4L, 4K), (3L, 6K).
So production function by giving the maximum possible output does only half the work. Because the same maximum possible output as given by the production function can be achieved using different combinations of the same inputs.
So the next question comes is, then which combination of inputs should be employed by the firm in order to achieve the desired level of output.
Answer to this is given by the Cost Function.
With given prices of input, the firm will choose the combination of Labor (L) and Capital (K) which will end up being least expensive for the firm i.e., the combination which results in the lowest cost of production. So for different level of output as targeted by a firm to achieve, the firm chooses the least cost incurring input combination.
The Cost Function defines the relationship between the cost of inputs and the output of a firm. For each level of output, the cost function describes the least cost of producing the same, with given prices of inputs or factors of production and technological know-how.
Combining the Production Function with Cost Function.
For a firm, it is assumed that the primary objective of a firm is to maximize the profits. And as we know, the excess of revenues over cost of production is termed as profit.
Hence it assumes two things as given i.e., earning maximum revenue and incurring least cost of production including targeting for least cost of input combinations too.
Maximum revenue can be earned by selling more and more of output and thus firms aim for maximum output. Now this problem is solved or taken care of by the production function which gives the maximum output that can be produced for a given technology. But production function gives more than one combination of inputs and hence the question remains which one to choose from?
The answer to this is then given by Cost Function, which describes the least cost input combination for producing each level of maximum output given by the production function.
So the cost function and production function coherently facilitates the economic decision making for a firm with confirming the maximum possible output for a firm at the least expensive input cost combination.
Conclusion
So production function by giving the maximum possible output does only half the work. Because the same maximum possible output as given by the production function can be achieved using different combinations of the same inputs.
So the next question comes is, then which combination of inputs should be employed by the firm in order to achieve the desired level of output.
Answer to this is given by the Cost Function.
With given prices of input, the firm will choose the combination of Labor (L) and Capital (K) which will end up being least expensive for the firm i.e., the combination which results in the lowest cost of production. So for different level of output as targeted by a firm to achieve, the firm chooses the least cost incurring input combination.
The Cost Function defines the relationship between the cost of inputs and the output of a firm. For each level of output, the cost function describes the least cost of producing the same, with given prices of inputs or factors of production and technological know-how.
Combining the Production Function with Cost Function.
For a firm, it is assumed that the primary objective of a firm is to maximize the profits. And as we know, the excess of revenues over cost of production is termed as profit.
Hence it assumes two things as given i.e., earning maximum revenue and incurring least cost of production including targeting for least cost of input combinations too.
Maximum revenue can be earned by selling more and more of output and thus firms aim for maximum output. Now this problem is solved or taken care of by the production function which gives the maximum output that can be produced for a given technology. But production function gives more than one combination of inputs and hence the question remains which one to choose from?
The answer to this is then given by Cost Function, which describes the least cost input combination for producing each level of maximum output given by the production function.
So the cost function and production function coherently facilitates the economic decision making for a firm with confirming the maximum possible output for a firm at the least expensive input cost combination.
Conclusion
In this session, we discussed in detail as to what is cost function. And then we discussed how the cost function with production function aids the decision making for a firm as regards to the production of maximum output with least input cost combination thus confirming the primary profit maximizing objective of the firm. Thus production function and cost function both when combined guides the firm in their profit maximizing objective.
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