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How businesses work

how businesses work

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How Businesses Work

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A business buys inputs from its suppliers. It uses those inputs to produce output—the goods and services it sells to its customers. The money the business pays for the inputs is its cost, and the money it receives from its customers is its revenue. Profit is the difference between revenue and cost. (LO4-1)

The inputs to production include labor, capital, land, intermediate inputs, and business know how. The production function summarizes the output of a business, given the levels of its inputs. The marginal product of labor is the

extra amount of output a business can generate by adding one more hour of labor or one more worker. (LO4-2)

The total cost of production is the sum of the costs for all of the inputs. The cost function for a business reports how much it will cost to produce a given level of output. Marginal cost is the added cost to produce one more unit of output. Variable costs can be quickly changed by the decisions of managers. Fixed costs take longer to change. (LO4-3)

Revenue is the amount of money companies get from selling their products or services. Marginal revenue is the added revenue from producing and selling one more unit of output. In perfect competition, the marginal revenue will be equal to the price. (LO4-4)

A profit-maximizing business will increase production as long as marginal revenue exceeds marginal cost. Short-term profit maximization holds fixed costs constant. Long-term profit maximization allows all inputs to vary. (LO4-5)

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