Chapter 5 Firm Production, Cost, and Revenue

Chapter 5Firm Production, Cost, and RevenueChapter OutlineProductionCostsRevenueProfit and Profit MaximizationBasic DefinitionsProfit: The money that business makes: Revenue minus CostCost: the expense that must be incurred in order to produce goods for saleRevenue : the money that comes into the firm from the sale of their goodsEconomic vs. Accounting CostEconomic Cost: All costs, both those that must be paid as well as those incurred in the form of forgone opportunities, of a businessAccounting Cost: Only those costs that must be explicitly paid by the owner of a businessProductionProduction Function: a graph which shows how many resources we need to produce various amounts of outputCost Function: a graph which shows how much various amounts of production costInputs to ProductionFixed Inputs: resources that you cannot changeVariable Inputs : resources that can be easily changedConcepts in ProductionDivision of Labor: workers divide up the tasks in such a way that each can build up a momentum and not have to switch jobsDiminishing Returns: the notion that there exists a point where the addition of resources increases production but does so at a decreasing rateFigure 1 The Production FunctionOutputWorkersProduction FunctionABCDA Numerical ExampleLaborTotal OutputExtra Output of the Group001100100231721735001834610110570090677070783060887040990030131000CostsFixed Costs: costs of production that we cannot changeVariable Costs: costs of production that we can changeFigure 2 The Total Cost FunctionOutputTotal CostTotal Cost FunctionABCDCost ConceptsMarginal Cost: the addition to cost associated with one additional unit of outputAverage Total Cost: Total Cost/Output, the cost per unit of productionAverage Variable Cost: Total Variable Cost/Output, the average variable cost per unit of productionAverage Fixed Cost: Total Fixed Cost/Output, the average fixed cost per unit of productionFigure 3 Marginal Cost, Average Total, Average Variable, and Average Fixed CostPQMCATCAVCAFCNumerical ExampleOutputTVCTFCTCMC*ATCAVCAFC0085008500100250085001100025110258520038008500123001362194330048008500133001044162840060008500145001236152150075008500160001532151760095008500180002030161470012500850021000303018128001700085002550045322110.6900225008500310005534259.41000325008500410001004132.58.5* MC is per 100RevenueMarginal Revenue : additional revenue the firm receives from the sale of each unitFigure 4 Setting the Price When There are Many CompetitorsOur FirmPMarket for MemoryPDSP*P*=Marginal RevenueFigure 5 Marginal Revenue When there are No Competitors MRMarket for MemoryPDNumerical Example For the Many Competitors CaseQPTRMR*0450100454,50045200459,000453004513,500454004518,000455004522,500456004527,000457004531,500458004536,000459004540,5004510004545,00045* MR is per 100Numerical Example For the No Competitors CaseQPTRMR*0750100707,000702006513,000603006018,000504005522,000405005025,000306004527,000207004028,000108003528,00009003027,000-1010002525,000-20Maximizing ProfitWe assume that firms wish to maximize profitsMarket FormsPerfect Competition: a situation in a market where there are many firms producing the same goodMonopoly: a situation in a market where there is only one firm producing the goodRules of ProductionA 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).Numerical Example of Profit Maximization With Many CompetitorsQPTRTCMRMCProfit04508,500-8,500100454,50011,0004525-6,500200459,00012,3004513-3,3003004513,50013,30045102004004518,00014,50045123,5005004522,50016,00045156,5006004527,00018,00045209,0007004531,50021,000453010,5008004536,00025,500454510,5009004540,50031,00045559,50010004545,00041,00045754,000Numerical Example of Profit Maximization With No CompetitorsQPTRTCMRMCProfit07508,500-8,500100707,00011,0007025-6,5002006513,00012,3006013-3,3003006018,00013,30050102004005522,00014,50040123,5005005025,00016,00030156,5006004527,00018,00020209,0007004028,00021,00010307,0008003528,00025,5000452,5009003027,00031,000-1055-4,00010002525,00041,000-2075-16,000