Answer to Question #75925 in Macroeconomics for DAVID

Question

1.what determines the amount of output in the economy?
2.explain how a competitive,profit-maximizing firm decides how much of each factor of production to demand.

Answer 1

1.The factors that determine the amount of output in the economy are:
a. The factors of production i.e. labor, capital, land etc. used to produce goods and services. The capital consists of physical capital(equipments, tools ,machinery etc) and financial capital.
b. The production technology or the level of technology used to convert production inputs into final goods /services.
2. A competitive firm, profit-maximizing firm produces a optimum quantity of output and sells them at a price which is above its average cost of production/unit output. The decision of how much of a factor of production is to be input, affects profits. To maximize profit, a firm chooses a quantity of output such that marginal revenue equals marginal cost. Because marginal revenue for a competitive firm equals the market price, the firm chooses quantity so that price equals marginal cost. For example, hiring an extra unit of labor increases output and therefore increases revenue; the firm compares this additional revenue to the additional cost from the higher wage bill. The additional revenue gained, depends on the marginal product of labor (MP) and the price of the good produced (P). Thus profit is given by:
∆Profit = ∆Revenue – ∆Cost = (MP x P ) – Wage
Let (MP x P )= Z
Thus if Z exceeds Wage then profit increases and the firm will hire labor until it is no longer profitable to do so—i.e. until the MP falls to the point where the change in profit is zero. This is also same for cost determination regarding physical capital.