Chapter 7:

1. Chapter 7: Impacts of Output Decisions on Short-Run Costs, Revenues, and Profits for Competitive Firms

2. Key Topics • Cost concepts • Cash and Non Cash • Variable and Fixed • Total: TFC, TVC, TC • Average: AFC, AVC, ATC, AVC & AP • Marginal: MC, MC & MP • Revenue concepts • Total • Marginal • Profit concepts • Profit maximizing output • Firm & market supply

3. Profit Overview (recall) • Profit = TR – TC • TR depends on P of output, Q of output • TC depends on P of inputs, Q of inputs, productivity of inputs, production technology used

4. Recent Examples of Firm ‘Cost’ Concerns • GM • Spent $5 billion to  costs of producing Saturn cars • Labor costs per car for GM were 2x Toyota’s • United, Delta, & other airlines - Southwest’s costs often 50% less • Sears, K-Mart, Target - Trying to compete with Walmart on basis of costs • Georgia Pacific • Started using ‘thinner’ saws • Less saw dust • 800 more rail cars of lumber per year

5. Cost Concepts (see Table 7.5) • Cash and Non Cash • Fixed and Variable • Total, Average, and Marginal

6. Opportunity Cost Examples

7. Total Fixed vs. Total Variable Costs TFC = total fixed costs = costs that have to be paid even if output = 0 = costs that do NOT vary with changes in output = ‘overhead’ and ‘sunk’ costs TVC = total variable costs = costs that DO vary with changes in output = 0 if output = 0 TC = total costs = TFC + TVC

8. Average Costs AFC = fixed costs per unit of output = TFC/q AVC = variable costs per unit of output = TVC/q ATC = total costs per unit of output = TC/q = AFC + AVC

9. Marginal Cost MC = additional cost per unit ofadditional output = = slope of TC and slope of TVC curves

10. Cost Tables • See 7.1, 7.2, 7.3, 7.4

11. Cost Curve Graphs TFC, AFC TVC, AVC TC, ATC MC (see Figs. 7.2 thru 7.8)

12. Product and Cost Relationships Assume variable input = labor • MP = ΔQ/ΔL • TVC = W ∙ L • MC = note: MC Δ is opposite of MP Δ • AVC = note: AVC Δ is opposite of AP Δ

13. MC, AVC, and ATC Relationships If MC > AVC  AVC is increasing If MC < AVC  AVC is declining If MC > ATC  ATC is increasing If MC < ATC  ATC is declining

14. Total Revenue (TR) and Marginal Revenue (MR) • Total revenue (TR) is the total amount that a firm takes in from the sale of its output. TR = P x q • Marginal revenue (MR) is the additional revenue that a firm takes in when it increases output by one additional unit. • In perfect competition, P = MR.

15. Comparing Costs and Revenues to Maximize Profit • The profit-maximizing level of output for all firms is the output level where MR = MC. • In perfect competition, MR = P, therefore, the firm will produce up to the point where the price of its output is just equal to short-run marginal cost. • The key idea here is that firms will produce as long as marginal revenue exceeds marginal cost.

16. Profit Max • Table (7.6) • MR = MC graph (Fig. 7.10) • TR, TC graph?

17. True or False? Fixed costs do not affect the profit-maximizing level of output? • True. Only, marginal costs (changes in variable costs) determine profit-maximizing level of output. Recall, profit-max output rule is to produce where MR = MC.

18. Firm & Market Supply Firm S = MC curve above AVC Market S = sum of individual firm supplies See Fig. 7.11

19. Q. Should a firm ‘shut down’ in SR? • Profit if ‘produce’ = TR – TVC – TFC Profit if ‘don’t produce’ or ‘shut down’ = -TFC  Shut down if • TR – TVC – TFC < -TFC • TR – TVC < 0 • TR < TVC