[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Profits, Costs, and Factors of
Production
A business that over time continually incurs losses will cease to exist, because it will
not have enough money to pay its bills. Businesses are under constant pressure to
make money. The need to make as much money as possible—maximizing profits—
provides a useful starting point for discussing the behavior of firms in competitive
markets.
The definition of profits is simple. Profits are equal to the money the business
receives from selling its products—its revenues—minus the costs of producing
those products:
profits = revenues − costs.
If a computer memory chip manufacturer sells 1 million chips at $0.20 each, its
revenues would be $200,000—$0.20 times the 1 million chips sold. The revenue a
business receives is just the quantity of the product it sells multiplied by the actual
price the firm received for the product that it sold. A firm’s costs are defined as the
total expenses of producing the good.
What the firm uses to produce the goods are called inputs or factors of production:
labor, materials, and capital goods. The firm’s total costs are simply the sum of the
costs of these inputs. Labor costs are what the company pays for the workers it hires
and the managers it employs to supervise them. The costs of materials include raw
materials and intermediate goods. Intermediate goods are whatever supplies the
company purchases from other firms—such as seeds, fertilizer, and gasoline for a
farm; or iron ore, coal, coke, limestone, and electric power for a steel company. The
costs of capital goods include the cost of machinery and structures such as buildings
and factories.
All firms work to keep their costs as low as possible. For given prices and levels
of output, a firm maximizes its profits by finding the least costly way of producing
its output. Thus, profit-maximizing firms are also cost-minimizing firms. Within
limits, firms can vary the mix of labor, materials, and capital goods they use; and
they will do so until they find the lowest-cost method of producing a given quality and
quantity of product.
PRODUCTION WITH ONE VARIABLE INPUT
The simplest way of understanding how firms find the lowest cost point is to look
at a firm with only two factors of production, one fixed (such as the amount of land
a farmer has or the number of plants a manufacturer has) and one that varies
with the level of production (such as the number of workers the firm hires). Not
surprisingly, inputs that vary with the level of production are said to be variable.
A wheat farmer with a fixed amount of land who uses only labor to produce his
crop is our example. The more labor he applies to the farm (his own time, plus the
time of workers that he hires), the greater the output. Labor is the single variable
factor (input).
132 ∂ CHAPTER 6 THE FIRM'S COSTS