Understanding Firm Production & Cost for Profit Maximization

1. Chapter 04Firm Production, Cost, and Revenue

2. Chapter Outline • Production • Costs • Revenue • Maximizing Profit

3. 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: themoney that comes into the firm from the sale of their goods

4. 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

5. Production • Production Function: a graph which showshow many resources we need to produce various amounts of output • Cost Function: a graph which shows how much various amounts of production cost

6. Inputs to Production • Fixed Inputs: resources that you cannot change • Variable Inputs: resources that can be easily changed

7. 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

8. Output D Production Function C B A Workers Figure 1 The Production Function

9. A Numerical Example

10. Costs • Fixed Costs: costs of production that we cannot change • Variable Costs: costs of production that we can change

11. Total Cost Total Cost Function D C B A Output Figure 2 The Total Cost Function

12. 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

13. P MC ATC AVC AFC Q Figure 3 Marginal Cost, Average Total, Average Variable, and Average Fixed Cost

14. Numerical Example * MC is per 100

15. Revenue • Marginal Revenue:additional revenue the firm receives from the sale of each unit

16. P P S P* P*=Marginal Revenue D Market for Memory Our Firm Figure 4 Setting the Price When There are Many Competitors

17. P MR D Market for Memory Figure 5 Marginal Revenue When there are No Competitors

18. Numerical Example For the Many Competitors Case * MR is per 100

19. Numerical Example For the No Competitors Case

20. Maximizing Profit • We assume that firms wish to maximize profits

21. 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

22. 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<AVC).

23. Numerical Example of Profit Maximization With Many Competitors

24. Numerical Example of Profit Maximization With No Competitors