The
firm is an organization that combines and organizes labor, capital and land or
raw materials for the purpose of producing goods and services for sale. The aim
of the firm is to maximize total profits or achieve some other related aim,
such as maximizing sales or growth. The basic production decision facing the
firm is how much of the commodity or services to produce and how much labor,
capital and other resources or inputs to use to produce that output most
efficiently. To answer these questions, the firm requires engineering or
technological data on production possibilities (the so called production
function) as well as economic data on input and output prices.
Production
refers to the transformation of inputs or resources into outputs of goods and
services. For example: IBM hires workers to use machinery, parts and raw
materials in factories to produce personal computers. The output of a firm can
either be a final commodity (such as personal computer) or an intermediate product
such as semiconductors (which are used in the production of computers and other
goods). The output can also be a service rather than a good. Examples of
services are education, medicine, banking, communication, transportation and
many others. To be noted is, that production refers to all of the activities
involved in the production of goods and services, from borrowing to set up or
expand production facilities, to hiring workers, purchasing raw materials,
running quality control, cost accounting and so on, rather than referring
merely to the physical transformation of inputs into outputs of goods and
services.
Inputs
are the resources used in the production of goods and services. As a convenient
way to organize the discussion, inputs are classified into labor. (Including
entrepreneurial talent), capital and land or natural resources. Each of these
broad categories however includes a great variety of the basic input. For
example, labor includes bus drivers, assembly line workers, accountants,
lawyers, doctor’s scientists and many others. Inputs are also classified as
fixed or variable. Fixed inputs are those that cannot be readily changed during
the time period under consideration, except at very great expense. Examples of
fixed inputs are the firm's plant and specialized equipment. On the other land,
variable inputs are those that can be varied easily and on the very short
notice. Examples of variable inputs are most raw materials and unskilled labor.
The time period during which at
least one input is fixed is called the short run, while the time period when
all inputs are variable is called the long run. The length of the long run
depends on the industry. For some, such as the setting up or expansion of a dry
cleaning business, the long run may be only few months or weeks. For others,
much as the construction of new electricity, generating plant, it may be many
years. In the short run, a firm can increase output only by using more of the
variable inputs together with the fixed inputs. In the long run, the same
increase in output could very likely be obtained more efficiently by also
expanding the firm's production facilities. Thus we say that the firm operates
in the short run and plans increases or reductions in its scale of operation in
the long run. In the long run, technology usually improves, so that more output
can be obtained from a given quantity of inputs or the same output from less
input.