Isues in economics today 6th by guell chapter04
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Chapter 04
Firm
Production,
Cost, and
Revenue
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Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
•
•
•
•
Production
Costs
Revenue
Maximizing Profit
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Basic Definitions
• Profit: The money that
business makes: Revenue
minus Cost
• Cost: the expense that must be
incurred in order to produce
goods for sale
• Revenue: the money that
comes into the firm from the
sale of their goods
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Economic vs. Accounting Cost
• Economic Cost: All costs, both
those that must be paid as well
as those incurred in the form of
forgone opportunities, of a
business
• Accounting Cost: Only those
costs that must be explicitly
paid by the owner of a business
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Production
• Production Function: a
graph which shows how many
resources we need to produce
various amounts of output
• Cost Function: a graph which
shows how much various
amounts of production cost
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Inputs to Production
• Fixed Inputs: resources that
you cannot change
• Variable Inputs: resources
that can be easily changed
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Concepts in Production
• Division of Labor: workers
divide up the tasks in such a
way that each can build up a
momentum and not have to
switch jobs
• Diminishing Returns: the
notion that there exists a point
where the addition of resources
increases production but does
so at a decreasing rate
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Figure 1 The Production Function
Output
D
C
A
Production
Function
B
Workers
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A Numerical Example
Labor
Total Output
Extra Output of the
Group
0
0
1
100
100
2
317
217
3
500
183
4
610
110
5
700
90
6
770
70
7
830
60
8
870
40
9
900
30
13
1000
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Costs
• Fixed Costs: costs of
production that we cannot
change
• Variable Costs: costs of
production that we can
change
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Figure 2 The Total Cost Function
Total
Cost
D
Total Cost Function
C
B
A
Output
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Cost Concepts
• Marginal Cost: the addition to cost
associated with one additional unit of output
• Average Total Cost: Total Cost/Output, the
cost per unit of production
• Average Variable Cost: Total Variable
Cost/Output, the average variable cost per
unit of production
• Average Fixed Cost: Total Fixed
Cost/Output, the average fixed cost per unit
of production
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Figure 3 Marginal Cost, Average Total,
Average Variable, and Average Fixed Cost
P
MC
ATC
AVC
AFC
Q
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Numerical Example
Outpu TVC
t
TFC
TC
MC*
ATC
AVC
AFC
0
0
8500
8500
100
2500
8500
1100
0
25
110
25
85
200
3800
8500
1230
0
13
62
19
43
300
4800
8500
1330
0
10
44
16
28
400
6000
8500
1450
0
12
36
15
21
500
7500
8500
1600
0
15
32
15
17
600
9500
8500
1800
0
20
30
16
14
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700
1250
8500
2100
30
30
18
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12
* MC is per 100
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Revenue
• Marginal Revenue:
additional revenue the firm
receives from the sale of each
unit
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Figure 4 Setting the Price
When There are Many Competitors
P
P
S
P*
P*=Marginal Revenue
D
Market for Memory
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Figure 5 Marginal Revenue
When there are No Competitors
P
MR
D
Market for Memory
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Numerical Example
For the Many Competitors Case
Q
P
TR
0
45
0
100
45
4,500
45
200
45
9,000
45
300
45
13,500
45
400
45
18,000
45
500
45
22,500
45
600
45
27,000
45
700
45
31,500
45
800
45
36,000
45
900
45
40,500
45
45
45,000
45
1000
* MR is per 100
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MR*
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Numerical Example For the
No Competitors Case
Q
P
TR
0
75
0
100
70
7,000
70
200
65
13,000
60
300
60
18,000
50
400
55
22,000
40
500
50
25,000
30
600
45
27,000
20
700
40
28,000
10
800
35
28,000
0
900
30
27,000
-10
1000
25
25,000
-20
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MR*
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Maximizing Profit
• We assume that firms wish to
maximize profits
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Market Forms
• Perfect Competition: a
situation in a market where
there are many firms producing
the same good
• Monopoly: a situation in a
market where there is only one
firm producing the good
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Rules of Production
• A firm should
a) produce an amount such that
Marginal Revenue equals
Marginal Cost (MR=MC),
unless
b) the price is less than the
average variable cost (P
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Numerical Example of Profit Maximization
With Many Competitors
Q
P
TR
TC
0
45
0
8,500
100
45
4,500
11,00
0
45
25
-6,500
200
45
9,000
12,30
0
45
13
-3,300
300
45
13,500
13,30
0
45
10
200
400
45
18,000
14,50
0
45
12
3,500
500
45
22,500
16,00
0
45
15
6,500
600
45
27,000
18,00
0
45
20
9,000
21,00
45
30
10,500
700
45
31,500
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MR
MC
Profit
-8,500
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Numerical Example of Profit Maximization
Q
P
0
With No Competitors
TR
TC
75
0
8,500
100
70
7,000
11,00
0
70
25
-6,500
200
65
13,000
12,30
0
60
13
-3,300
300
60
18,000
13,30
0
50
10
200
400
55
22,000
14,50
0
40
12
3,500
500
50
25,000
16,00
0
30
15
6,500
600
45
27,000
18,00
0
20
20
9,000
700
40
28,000
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MR
MC
Profit
-8,500
21,00
10
30
7,000
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