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THE FIRM ’ S BASIC PROFIT MAXIMIZATION PROBLEM

Chapter 2 slide 1. THE FIRM ’ S BASIC PROFIT MAXIMIZATION PROBLEM. What Quantity of Output should the Firm Produce and Sell and at What Price?. The Answer depends on Revenue and Cost Predictions. The Solution is Found using Marginal Analysis. Expand an Activity if and only if

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THE FIRM ’ S BASIC PROFIT MAXIMIZATION PROBLEM

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  1. Chapter 2 slide 1 THE FIRM’S BASIC PROFITMAXIMIZATION PROBLEM What Quantity of Output should the Firm Produce and Sell and at What Price? The Answer depends on Revenue and Cost Predictions. The Solution is Found using Marginal Analysis. Expand an Activity if and only if the Extra Benefit exceeds the Extra Cost.

  2. 2.2 MAXIMIZING PROFITFROM MICROCHIPS A1. Focus on a single Product, A2. whose Revenues and Costs can be predicted with Certainty. Write profit as  = R - C Price ($ 000) Revenue can be predicted using the Demand Curve. 170 130 90 50 P = 170 - 20Q or equivalently, Q = 8.5 - .05P Quantity in Lots 0 2 4 6 8

  3. 2.3 The Firm determines Output where MR = MC. THE FIRM’S OPTIMAL OUTPUT DECISION R, C  C = 100 + 38Q 300 200 100 0 -100 R = 170Q - Q2 M= 0  Q 0 2 4 6 8 3.3

  4. 2.4 MAXIMIZING PROFITALGEBRAIC SOLUTIONS Start with Demand and Cost Information P = 170 - 20Q and C = 100 + 38Q Therefore, R = 170Q - 20Q2 so MR = 170 - 40Q and MC = 38 Setting MR = MC implies 170- 40Q = 38 or 132 = 40Q Q* = 132/40 = 3.3 lots P* = 170 - (20)(3.3) = $104 K * = 343.2 - 225.4 = 117.8

  5. 2.5 MAXIMIZING PROFIT USING MARGINAL GRAPHS There is always a tradeoff. Set MR = MC. 170 P* Maximum Contribution Demand MC 38 MR Q*

  6. 2.6 SENSITIVITY ANALYSIS Considers changes in: Fixed Costs, Marginal costs, or Demand Conditions A change in fixed cost has no effect on Q* or P* (because MR and MC are not affected). 170 P* Demand MC 38 Q*

  7. 2.7 SENSITIVITY ANALYSIS Considers changes in: Marginal costs An increase in MC implies a fall in Q and an increase in P. 170 Demand MC’ MC 38 Q’ Q*

  8. 2.8 Finally, consider a change in Demand Conditions. SENSITIVITY ANALYSIS 170 P P* Shift in Demand MC 38 Q Q*

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