Understanding Production Costs and Maximizing Profit

1. Do Now • According to some reports, supermarkets make a profit of three to six cents for every dollar of revenue. • Where does the rest of the money go????

2. Costs of Production

3. Labor and Output • One basic question that any business owner has to answer is how many workers to hire. • Owners have to consider how the number of workers they hire will affect their total production.

4. Marginal Product of Labor: the change in output from hiring one additional unit of labor (person)

5. Increasing Marginal Returns: a level of production in which the marginal product of labor increases as the number of workers increases

6. Diminishing Marginal Returns: a level of production at which the marginal product of labor decreases as the number of workers increases

7. Negative Marginal Returns: when workers get in each other’s way and disrupt production, so overall output decreases

8. Production Costs • Fixed Costs: a cost that does not change, no matter how much of a good is produced

9. Production Costs • Variable Costs: a cost that rises or falls depending on the quantity produced • Ex: salary for part-time employees, the cost of the electricity that a store uses during business hours

10. Production Costs • Total Costs: the sum of fixed costs plus variable costs – the amount of money needed to operate a business

11. Production Costs • Marginal Costs: the cost of producing one more unit of a good

12. Output • Marginal Revenue: the additional income from selling one more unit of a good; sometimes equal to price

13. Output • Average cost: the total cost divided by the quantity produced

14. Output • Operating Cost: the cost of operating a facility, such as a factory, a store, or a school

15. Sum it up • Firms look for highest marginal return product of labor; they avoid negative marginal return • Firms set output where marginal revenue equals marginal cost • Firms continue to operate as long as total revenues exceed variable cost • Firms make business decisions by weighing various types of cost against various types of revenue

16. To Maximize Profit…