6 Cost
In Chapter 5 we reviewed the theoretical implications of the technological process whereby factors of production are efficiently transformed into goods and services for sale in the market. The production function defines the maximum rate of output per unit of time obtainable from a given set of productive inputs. The production function, however, was presented as a purely technological relationship devoid of any behavioral assertions underlying motives of management. The optimal combination of inputs used in the production process will differ depending on the firm’s organizational objectives. The objective of profit maximization, for example, may require that the firm use one set of productive resources, while maximization of revenue or market share may require a completely different set. The substitutability of inputs in the production process indicates that any given level of output may be produced with multiple factor combinations. Deciding which of these combinations is optimal not only depends on a well-defined organizational objective but also requires that management attempt to achieve this objective while constrained by a limited operating budget and constellation of factor prices. Changes in the budget constraints or factor prices will alter the optimal combination of inputs. The purpose of this chapter is to bridge the gap between production as a purely technological relationship and the cost of producing a level of output to achieve a well-defined organizational objective.
THE RELATIONSHIP BETWEEN PRODUCTION AND COST The cost function of a profit-maximizing firm shows the minimum cost of producing various output levels given market-determined factor prices 235
