Economics | Production and consumption

Welcome to Production & Consumption!

Hey everyone! Ever wondered how your favourite bubble tea gets made, or how massive companies like Apple produce millions of iPhones? This chapter is all about that journey! We'll explore the world of firms (the businesses that make things), the different types of goods they produce, and the smart ways they organise production to be efficient. Think of it as a backstage pass to the economy. Understanding this is super important because it's the foundation of how we get all the stuff we use every day. Let's get started!

1. Firms and Production: The Basics

What is a Firm?

A firm is simply an organisation that makes decisions on how to use resources to produce goods and services. It's the "chef" in the economy's kitchen. It gathers ingredients (like labour, machines, and raw materials) and decides how to combine them to create something people want to buy.

Example: A local bakery is a firm. It decides how many bakers to hire (labour), what ovens to buy (capital), and how many loaves of bread to bake each day (production of goods).

Types/Stages of Production

Production can be broken down into three main stages. They are all linked together!

• Primary Production: This involves extracting raw materials directly from the earth. Think farming, mining, fishing, and forestry.
  Example: A farmer growing wheat.

• Secondary Production: This is the manufacturing stage, where raw materials are turned into finished or semi-finished goods.
  Example: A factory using the wheat from the farmer to make flour, and then a bakery using the flour to make bread.

• Tertiary Production: This involves providing services rather than making physical goods. This includes retail, banking, transportation, tourism, and education.
  Example: A supermarket selling the bread to customers. A delivery driver bringing the bread to the store.

Did you know?

Hong Kong's economy is heavily dominated by tertiary production! Over 90% of our economy is based on services like finance, logistics, and tourism. We rely on other places for most of our primary and secondary production.

Key Takeaway

Firms turn resources into goods and services through three stages: Primary (extracting), Secondary (making), and Tertiary (serving).

2. Forms of Business Ownership

Firms can be owned in different ways. The two main categories are public ownership and private ownership.

Public Ownership

A publicly owned firm is owned and operated by the government. The main goal is usually to provide essential services to the public, not just to make a profit.

Examples in Hong Kong: Public hospitals (like Queen Mary Hospital), the Hong Kong Post Office.

Private Ownership

These firms are owned by private individuals. Their main goal is usually to earn a profit. There are a few main types you need to know:

1. Sole Proprietorship (一人獨資)

• Owners: Just one person.
• Legal Status: The owner and the business are the same legal entity.
- Liability: Unlimited liability. This is a super important point! It means if the business has debts, the owner is personally responsible for paying them all, even if it means selling their own car or apartment.
• Advantages: Easy to set up, owner keeps all profits, flexible decision-making.
• Disadvantages: Unlimited liability (big risk!), hard to raise money, the business ends if the owner quits or dies.
• Example: A small neighbourhood tutor, a local fruit stall owner.

2. Partnership (合夥)

• Owners: 2 to 20 people (usually).
• Legal Status: The owners and the business are considered the same.
• Liability: Usually unlimited liability for all partners. The actions of one partner can affect all other partners.
• Advantages: More capital than a sole proprietorship, shared workload and risks.
• Disadvantages: Unlimited liability, potential for disagreements between partners, profits are shared.
• Example: Many law firms and accounting firms are partnerships.

3. Limited Company (有限公司)

This is a big one! The key feature is in the name: "limited".

• Legal Status: The company is a separate legal entity from its owners (shareholders). It's like the company is its own "person" in the eyes of the law.
• Liability: Limited liability. This is the biggest advantage! Owners are only liable for the amount of money they invested in the company. Their personal assets are safe from business debts.
• There are two types:

  • Private Limited Company (私人有限公司): Shares are NOT sold to the general public. Usually owned by a smaller group of people.
    Example: Many family-run businesses are set up this way.

  • Public Limited Company (公眾有限公司): Shares CAN be sold to the general public on the stock exchange.
    Example: Big companies like HSBC, Tencent, and MTR Corporation are public limited companies.

• Advantages: Limited liability, easier to raise large amounts of capital, business continues even if owners change.
• Disadvantages: More complicated and expensive to set up, profits are shared among many shareholders (as dividends).

Quick Review: Limited vs. Unlimited Liability

This concept can be tricky, but it's crucial!

• Unlimited Liability: "It's ALL on you." Your personal money and assets are at risk if the business fails. (Sole Proprietorship, Partnership)
• Limited Liability: "You only lose what you put in." The maximum you can lose is the money you invested in shares. Your personal assets are safe. (Limited Companies)

Raising Money: Shares vs. Bonds

Limited companies often need to raise money. They can do this by issuing shares or bonds.

Shares (股票):

• When you buy a share, you become a part-owner of the company.
• You get a share of the profits (called dividends).
• The return is not fixed - it depends on how well the company does. It's higher risk, but potentially higher reward.

Bonds (債券):

• When you buy a bond, you are lending money to the company. You are a creditor, not an owner.
• The company promises to pay you back the full amount on a specific date, plus regular interest payments.
• The return (interest) is usually fixed. It's lower risk and generally lower reward than shares.

Key Takeaway

The form of ownership determines the owner's liability (unlimited or limited). Sole proprietorships and partnerships have unlimited liability, while limited companies offer their owners the protection of limited liability.

3. Types of Goods and Services

Firms produce different kinds of goods. It's important to know how to classify them.

Producer Goods vs. Consumer Goods

• Producer Goods (or Capital Goods): These are goods used to produce other goods and services. They are not for final consumption.
  Examples: An oven in a bakery, a sewing machine in a clothing factory, a delivery truck.

• Consumer Goods: These are goods for the final satisfaction of wants by households.
  Examples: The bread you buy from the bakery, the T-shirt you wear, the smartphone you use.

Private Goods vs. Public Goods

This is about the characteristics of the good itself.

Private Goods

Most goods we buy are private goods. They have two key characteristics:

1. Rival in consumption: If one person consumes it, another person cannot consume the same unit.
   Example: If I eat an apple, you cannot eat that same apple.

2. Excludable in consumption: People can be prevented from using the good if they don't pay for it.
   Example: The shop owner won't give you the apple unless you pay for it.

Public Goods

Public goods are the opposite. They are rare!

1. Non-rival in consumption: One person's consumption does not reduce the amount available for others.
   Example: Me looking at a street light doesn't stop you from looking at it. We can both use it at the same time.

2. Non-excludable in consumption: It is very difficult or impossible to prevent people who haven't paid from consuming it.
   Example: How would you stop someone from benefiting from national defence or a street light?

Examples of public goods: National defence, street lighting, flood control systems.

⚠️ Common Mistake Alert!

Don't confuse "public goods" with goods "provided by the public sector (government)". A public hospital is provided by the government, but it is NOT a public good. Why? Because medical treatment is rival (a doctor treating me can't treat you at the exact same time) and excludable (you can be denied treatment if you don't pay or meet certain criteria). Always check for non-rivalry and non-excludability!

4. Division of Labour (Specialization)

Division of labour means breaking down a production process into a series of small, specialized tasks, with each worker focusing on just one task. Think of an assembly line.

Types of Division of Labour

• Simple: Based on trade or occupation. E.g., one person is a baker, another is a doctor, another is a teacher.

• Complex: Breaking down one production process into many simple tasks. E.g., in a car factory, one worker fits the wheels, another installs the engine, and another paints the body.

• Regional: Different regions or countries specialize in producing different goods based on their advantages. E.g., Japan specializes in high-tech electronics, while Brazil specializes in coffee.

Advantages and Disadvantages

Advantages:

• Practice makes perfect: Workers become very skilled and fast at their specific task.
• Saves time: Less time is wasted moving between tasks or changing tools.
• Better use of machinery: It's easier to design and use specialized machines for simple, repetitive tasks.
• Higher productivity and output!

Disadvantages:

• Work becomes boring and repetitive: This can lower morale and the quality of work.
• Greater risk of unemployment: A worker skilled in only one tiny task may find it hard to get another job if they are replaced by a machine.
• Disruption is costly: If one part of the assembly line stops, the entire production process can grind to a halt.

Key Takeaway

Division of labour (specialization) boosts productivity but can make work boring and create dependencies in the production process.

5. The Factors of Production

These are the basic "ingredients" that firms use to produce goods and services. There are four of them.

Memory Aid: Remember CELL

Capital, Entrepreneurship, Labour, Land

1. Land (Natural Resources)

This includes all natural resources, not just physical land. It includes minerals, oil, forests, rivers, and the land itself. The key feature is that its supply is fixed; humans cannot create more of it.

2. Labour (Human Resources)

This is the physical and mental effort of people used in production.

• Labour Supply: The total number of hours workers are willing and able to work. It's affected by factors like wages, population size, and education levels.

• Labour Productivity: This measures how efficient labour is. We often calculate the average labour productivity.
  $$ \text{Average Labour Productivity} = \frac{\text{Total Output}}{\text{Number of Labourers}} $$
  Example: If 10 workers produce 500 T-shirts a day, the average labour productivity is 500 / 10 = 50 T-shirts per worker.

• Labour Mobility: How easily workers can move between jobs.

  • Occupational Mobility: Ease of moving between different types of jobs (e.g., a teacher becoming a lawyer).
  • Geographical Mobility: Ease of moving to a different location for work (e.g., moving from Tuen Mun to work in Quarry Bay).

3. Capital (Man-made Resources)

These are man-made goods used to produce other goods. This includes machinery, tools, factories, and equipment. Capital accumulation is the process of increasing the amount of capital, which requires giving up present consumption to invest for the future.

4. Entrepreneurship (Human Resources)

This is a special human resource. The entrepreneur is the person who:

• Bears Risks: They risk their own money and time to start and run the business, with no guarantee of success.
• Makes Decisions: They organise the other three factors of production (land, labour, capital) to produce goods and services.

An entrepreneur is the visionary and the risk-taker!

6. Production and Costs in the Short Run

Don't worry if this sounds technical! We'll break it down. In economics, "short run" and "long run" don't refer to a specific time period like weeks or years.

Short Run vs. Long Run

• Short Run: A period where at least one factor of production is fixed. A firm can change its output by changing its variable factors, but not its fixed factors.
  Example: A restaurant wants to serve more customers tonight. It can hire more waiters (variable factor) but it can't instantly build a bigger kitchen (fixed factor).

• Long Run: A period where all factors of production are variable. The firm has enough time to change everything, including its scale of production.
  Example: If the restaurant is popular for a year, it might decide to expand by leasing the shop next door. In the long run, the kitchen size is no longer fixed.

Fixed Factors and Variable Factors

• Fixed Factors: Inputs that do not change with the level of output in the short run. (e.g., factory building, large machinery)
• Variable Factors: Inputs that do change with the level of output in the short run. (e.g., raw materials, electricity, most workers)

The Law of Diminishing Marginal Returns

This is a fundamental concept for the short run. It states:

As a firm continuously adds more units of a variable factor (e.g., labour) to a fixed factor (e.g., a factory), the marginal product (the extra output from one more unit of the variable factor) will eventually decrease.

Think about it with a simple analogy: Imagine one bubble tea shop (fixed factor) and you keep adding more and more staff (variable factor). At first, adding a second worker helps a lot. A third might help even more. But what about the 10th worker? Or the 20th? Eventually, they will get in each other's way because the shop space and machines are limited. The extra output from each new worker (marginal product) will start to fall.

Illustration with a Schedule

Let's look at the numbers. Don't panic! We'll go step-by-step.

• Total Product (TP): The total output produced.
• Average Product (AP): Output per worker. $$ AP = TP \div \text{No. of Workers} $$
• Marginal Product (MP): The extra output from adding ONE more worker. $$ MP = \text{Change in TP} \div \text{Change in No. of Workers} $$

Here is an example schedule for a T-shirt factory with a fixed number of machines:

No. of Workers | Total Product (TP) | Marginal Product (MP) | Average Product (AP)
------------------|-----------------------|---------------------------|--------------------------
0 | 0 | - | -
1 | 10 | 10 (10 - 0) | 10 (10 / 1)
2 | 25 | 15 (25 - 10) | 12.5 (25 / 2)
3 | 45 | 20 (45 - 25) | 15 (45 / 3)
4 | 60 | 15 (60 - 45) | 15 (60 / 4)
5 | 70 | 10 (70 - 60) | 14 (70 / 5)
6 | 75 | 5 (75 - 70) | 12.5 (75 / 6)

Notice that after the 3rd worker, the Marginal Product (MP) starts to decrease (from 20 to 15 to 10...). This is the Law of Diminishing Marginal Returns in action!

Costs of Production

Costs follow a similar pattern based on fixed and variable factors.

• Fixed Costs (FC): Costs that do not change with output. The cost of the fixed factors. E.g., rent for the factory.
• Variable Costs (VC): Costs that do change with output. The cost of the variable factors. E.g., cost of cotton to make T-shirts.
• Total Cost (TC): $$ TC = FC + VC $$
• Average Cost (AC): Cost per unit. $$ AC = TC \div \text{Output} $$
• Marginal Cost (MC): The extra cost of producing ONE more unit of output. $$ MC = \text{Change in TC} \div \text{Change in Output} $$

The key idea is that as diminishing marginal returns set in (each worker produces less extra output), the marginal cost (the cost of producing extra output) will start to rise.

7. Economies and Diseconomies of Scale

This is a long-run concept. It's about what happens to the average cost of production when a firm changes its entire scale of operation (i.e., gets bigger or smaller).

Economies of Scale (規模經濟)

This happens when a firm's long-run average cost decreases as it increases its scale of production. Basically, "bigger is cheaper" (per unit).

• Internal Economies of Scale: Cost advantages that happen inside the firm as it grows.

  • Technical: Larger firms can afford more efficient, specialized machinery.
  • Financial: Larger firms can get cheaper loans from banks because they are seen as less risky.
  • Marketing: A big firm's advertising budget is spread over more units of sales, so the cost per unit is lower.
  • Purchasing: They can buy raw materials in bulk and get discounts.

• External Economies of Scale: Cost advantages that happen because the entire industry is growing in a certain area.

  • Pool of skilled labour: A concentration of firms (e.g., tech companies in a science park) attracts skilled workers to the area, making it easier for all firms to hire.
  • Development of support industries: Specialized suppliers and repair services may set up nearby, reducing costs for all firms in the industry.

Diseconomies of Scale (規模負經濟)

This happens when a firm's long-run average cost increases as it increases its scale of production. The firm becomes "too big for its own good".

• Internal Diseconomies of Scale: Problems that arise inside the firm as it becomes too large.

  • Management problems: It becomes difficult to coordinate and control thousands of employees. Communication breaks down, and decision-making slows.
  • Low morale: Workers may feel alienated and unimportant in a giant organisation, leading to lower productivity.

• External Diseconomies of Scale: Problems that arise because the entire industry in an area has grown too large.

  • Increased competition for resources: Firms have to compete for labour and raw materials, driving up wages and prices.
  • Congestion: Increased traffic in the area can raise transport costs for all firms.

Key Takeaway

As a firm gets bigger, it first enjoys falling average costs (economies of scale), but if it gets too big, its average costs may start to rise (diseconomies of scale).

8. Firm Expansion and Objectives

Expansion and Integration

Firms can grow by integrating with other firms. The main motives are to increase market power, gain economies of scale, or secure supplies.

• Horizontal Integration: Merging with a firm at the same stage of production.
  Example: Nike merging with Adidas.

• Vertical Integration: Merging with a firm at a different stage of production.

  • Backward Vertical: Merging with a supplier. (e.g., A car maker buys a tyre company.)
  • Forward Vertical: Merging with a customer/distributor. (e.g., A movie studio buys a cinema chain.)

• Conglomerate Integration: Merging with a firm in a completely unrelated industry.
  Example: A food company buying an insurance company.

Objectives of Firms

What is the main goal of a firm? In economics, we usually assume it is profit maximization.

Profit Maximization:

• Profit = Total Revenue (TR) - Total Cost (TC)
• A firm will choose to produce the level of output where its profit is highest. For a firm that just takes the market price (a price-taker), it will keep producing as long as the price it receives for a unit is greater than or equal to the marginal cost of producing it.
• This is why the firm's marginal cost schedule shows its supply – it shows how much the firm is willing to produce at different prices.

However, firms may have other objectives too:

• Increase Market Share: The firm may want to be the biggest player in the market, even if it means lower profits in the short term.
• Provision of Non-profit Services / Corporate Social Responsibility (CSR): Some firms aim to benefit society, protect the environment, or provide community services, alongside making a profit.