Production & Profits

Production and Profits Jennifer and Jason run an organic tomato farm Jennifer and Jason run an organic tomato farm The market price of organic tomatoes is $18 per bushel The market price of organic tomatoes is $18 per bushel Jennifer and Jason are price takers – they can sell as much as they like at that price Jennifer and Jason are price takers – they can sell as much as they like at that price What is there profit-maximizing level of output by direct calculation? What is there profit-maximizing level of output by direct calculation?

Production and Profit Total Revenue = P x Q Total Revenue = P x Q Profit = TR – TC Profit = TR – TC Profit is maximized at an output of 5 bushels, where profit is equal to $18 Profit is maximized at an output of 5 bushels, where profit is equal to $18

Marginal Analysis & Profit- Maximizing Quantity of Output Marginal Analysis is when the optimal amount of an activity is the level at which marginal benefit is equal to marginal cost Marginal Analysis is when the optimal amount of an activity is the level at which marginal benefit is equal to marginal cost To apply to profit-maximization: considering the effect on a producer’s profit of increasing output by one unit To apply to profit-maximization: considering the effect on a producer’s profit of increasing output by one unit Marginal revenue is the change in total revenue generated by an additional unit of output Marginal revenue is the change in total revenue generated by an additional unit of output

Marginal Analysis & Profit- Maximizing Quantity of Output Marginal revenue formula: Marginal revenue formula: MR = ∆TR/∆Q

Marginal Analysis & Profit- Maximizing Quantity of Output Jennifer and Jason can maximize their profit by producing bushels up to the point at which the marginal revenue is equal to marginal cost Jennifer and Jason can maximize their profit by producing bushels up to the point at which the marginal revenue is equal to marginal cost Producer’s optimal output rule: profit is maximized by producing the quantity at which the MR of the last unit produced is equal to its marginal cost Producer’s optimal output rule: profit is maximized by producing the quantity at which the MR of the last unit produced is equal to its marginal cost MR = MC at the optimal quantity of output

Marginal Analysis & Profit- Maximizing Quantity of Output

The net gain being negative in the 6 th and 7 th bushels illustrates another rule: The net gain being negative in the 6 th and 7 th bushels illustrates another rule: Price-taking firm’s optimal output rule – a price taking firm’s profit is maximized by producing the quantity of out put at which the market price is equal to the marginal cost of the last unit produced Price-taking firm’s optimal output rule – a price taking firm’s profit is maximized by producing the quantity of out put at which the market price is equal to the marginal cost of the last unit produced P = MC at the price-taking firm’s optimal quantity of output P = MC at the price-taking firm’s optimal quantity of output

Marginal Analysis & Profit- Maximizing Quantity of Output Really, the price-taking firm’s optimal output rule is just an application of the optimal output rule to the case of a price-taking firm Really, the price-taking firm’s optimal output rule is just an application of the optimal output rule to the case of a price-taking firm WHY? WHY? In the case of a price-taking firm, marginal revenue is equal to the market price In the case of a price-taking firm, marginal revenue is equal to the market price

The Price-Taking Firm’s Profit-Maximizing Quantity of Output $ Price, cost of bushel Quantity of tomatoes (bushels) MC MR= P E Profit-maximizing quantity Optimal point Market price The marginal revenue curve shows how marginal revenue varies as output varies

Marginal Analysis & Profit- Maximizing Quantity of Output Are all price-taking firm’s production decision summed up as “produce up to the point where marginal cost of production is equal to the price?” Are all price-taking firm’s production decision summed up as “produce up to the point where marginal cost of production is equal to the price?” NO! NO! Before you apply Marginal Analysis to determine how much to produce, a producer must answer an “either-or” question—should it produce at all? Before you apply Marginal Analysis to determine how much to produce, a producer must answer an “either-or” question—should it produce at all?

When is Production Profitable? Economic profit is the measure based on the opportunity cost of resources used in the business Economic profit is the measure based on the opportunity cost of resources used in the business To calculate economic profit, a firm’s total cost incorporates the implicit cost (benefits forgone in the next best use of the firm’s resources) as well as explicit cost incurred by the firm To calculate economic profit, a firm’s total cost incorporates the implicit cost (benefits forgone in the next best use of the firm’s resources) as well as explicit cost incurred by the firm

When is Production Profitable? What determines if Jennifer and Jason’s farm earns a profit or generates a loss? What determines if Jennifer and Jason’s farm earns a profit or generates a loss? Whether the market price of organic tomatoes is more or less than the farm’s minimum average total cost Whether the market price of organic tomatoes is more or less than the farm’s minimum average total cost

Calculation of short-run AVC and short-run ATC **short-run due to all variables are fixed costs**

Costs and Production in the Short Run $ MC ATC MR= P C Break even price Minimum-cost output Price, cost of bushel Quantity of tomatoes (bushels) Minimum average total cost

When is Production Profitable? Profit is equal t o total revenue minus total cost, TR-TC: Profit is equal t o total revenue minus total cost, TR-TC: If TR > TC, the firm is profitable. If TR > TC, the firm is profitable. If TR = TC, the firm breaks even. If TR = TC, the firm breaks even. If TR < TC, the firm incurs a loss. If TR < TC, the firm incurs a loss.

When is Production Profitable? Also can express this in terms of revenue and cost per unit of output Also can express this in terms of revenue and cost per unit of output Divide profit by number of units of output, Q: Divide profit by number of units of output, Q: Profit/Q = TR/Q – TC/Q TR/Q is average revenue (market price) TR/Q is average revenue (market price) TC/Q is average total cost TC/Q is average total cost

Profitability and the Market Price MC Profit ATC MR= P C Z E Market Price = $ $18 Price, cost of bushel Quantity of tomatoes (bushels) Minimum average total cost Break even price Area of the shaded rectangle shows Jennifer and Jason’s total profit when market price is $18. Can be expressed: Profit = TR – TC = (TR/Q – TC/Q) x Q Or Profit = (P – ATC) x Q

Profitability and the Market Price MC Loss ATC MR= P C A Y Market Price = $ $14.67 Price, cost of bushel Quantity of tomatoes (bushels) Minimum average total cost Break even price

Profitability and the Market Price How does a producer know, in general, whether or not its business will be profitable? How does a producer know, in general, whether or not its business will be profitable? Need to compare the market price to the producer’s minimum average total cost Need to compare the market price to the producer’s minimum average total cost

Profitability and the Market Price MC Loss ATC MR= P C A Y Market Price = $ $14.67 Price, cost of bushel Quantity of tomatoes (bushels) Minimum average total cost Break even price For Jennifer and Jason, minimum average total cost ($14) occurs at an output quantity of 4 bushels. Whenever market price exceeds minimum average total cost, the producer can find some output level for which the average total cost is less than the market price. If the market price is less than minimum average total cost, there is not output level at which price exceeds average total cost. Due to this, the firm will be unprofitable at any quantity of output.

Profitability and the Market Price Minimum average total cost of a price- taking firm is its break-even price Minimum average total cost of a price- taking firm is its break-even price – The price at which it earns zero profit (called economic profit) – At firm will earn positive profit when the market price is above the break-even price and it will suffer losses when the market price is below the break-even price

Profitability and the Market Price Rules determining whether a producer of a good is profitable depends on a comparison of the market price of the good to the producer’s break-even price: Rules determining whether a producer of a good is profitable depends on a comparison of the market price of the good to the producer’s break-even price: 1.Whenever market price exceeds minimum average total cost, the producer is profitable. 2.Whenever the market price equals minimum average total cost, the producer breaks even. 3.Whenever market price is less than minimum average total cost, the producer is unprofitable.

Production & Profits Notes

Production and Profit Total Revenue = Total Revenue = Profit = Profit = Profit is maximized at an output of 5 bushels, where profit is equal to $18 Profit is maximized at an output of 5 bushels, where profit is equal to $18

Marginal Analysis & Profit- Maximizing Quantity of Output Marginal Analysis is Marginal Analysis is To apply to profit-maximization: considering the effect on a producer’s profit of increasing output by one unit To apply to profit-maximization: considering the effect on a producer’s profit of increasing output by one unit Marginal revenue is the change in total revenue generated by an additional unit of output Marginal revenue is the change in total revenue generated by an additional unit of output

Marginal Analysis & Profit- Maximizing Quantity of Output Marginal revenue formula: Marginal revenue formula:

Marginal Analysis & Profit- Maximizing Quantity of Output Jennifer and Jason can maximize their profit by producing bushels up to the point at which the marginal revenue is equal to marginal cost Jennifer and Jason can maximize their profit by producing bushels up to the point at which the marginal revenue is equal to marginal cost Producer’s optimal output rule: Producer’s optimal output rule:

Marginal Analysis & Profit- Maximizing Quantity of Output

The net gain being negative in the 6 th and 7 th bushels illustrates another rule: The net gain being negative in the 6 th and 7 th bushels illustrates another rule: Price-taking firm’s optimal output rule – Price-taking firm’s optimal output rule – P = MC at the price-taking firm’s optimal quantity of output P = MC at the price-taking firm’s optimal quantity of output

Marginal Analysis & Profit- Maximizing Quantity of Output Really, the price-taking firm’s optimal output rule is just an application of the optimal output rule to the case of a price-taking firm Really, the price-taking firm’s optimal output rule is just an application of the optimal output rule to the case of a price-taking firm WHY? WHY? In the case of a price-taking firm, marginal revenue is equal to the market price In the case of a price-taking firm, marginal revenue is equal to the market price

The Price-Taking Firm’s Profit-Maximizing Quantity of Output $ Price, cost of bushel Quantity of tomatoes (bushels) MC MR= P E Profit-maximizing quantity Optimal point Market price

Marginal Analysis & Profit- Maximizing Quantity of Output Are all price-taking firm’s production decision summed up as “produce up to the point where marginal cost of production is equal to the price?” Are all price-taking firm’s production decision summed up as “produce up to the point where marginal cost of production is equal to the price?” NO! NO! Before you apply Marginal Analysis to determine how much to produce, a producer must answer an “either-or” question—should it produce at all? Before you apply Marginal Analysis to determine how much to produce, a producer must answer an “either-or” question—should it produce at all?

When is Production Profitable? Economic profit is the measure based on the opportunity cost of resources used in the business Economic profit is the measure based on the opportunity cost of resources used in the business To calculate economic profit, To calculate economic profit,

When is Production Profitable? What determines if Jennifer and Jason’s farm earns a profit or generates a loss? What determines if Jennifer and Jason’s farm earns a profit or generates a loss? Whether the market price of organic tomatoes is more or less than the farm’s minimum average total cost Whether the market price of organic tomatoes is more or less than the farm’s minimum average total cost

Calculation of short-run AVC and short-run ATC **short-run due to all variables are fixed costs**

Costs and Production in the Short Run $ MC ATC MR= P C Break even price Minimum-cost output Price, cost of bushel Quantity of tomatoes (bushels) Minimum average total cost

When is Production Profitable? Profit is equal t o total revenue minus total cost, TR-TC: Profit is equal t o total revenue minus total cost, TR-TC: If TR > TC, If TR > TC, If TR = TC, If TR = TC, If TR < TC, If TR < TC,

When is Production Profitable? Also can express this in terms of revenue and cost per unit of output Also can express this in terms of revenue and cost per unit of output Divide profit by number of units of output, Q: Divide profit by number of units of output, Q: TR/Q is average revenue (market price) TR/Q is average revenue (market price) TC/Q is average total cost TC/Q is average total cost

Profitability and the Market Price MC ATC MR= P C Z E Market Price = $ $18 Price, cost of bushel Quantity of tomatoes (bushels) Minimum average total cost Break even price

Profitability and the Market Price MC ATC MR= P C A Y Market Price = $ $14.67 Price, cost of bushel Quantity of tomatoes (bushels) Minimum average total cost Break even price

Profitability and the Market Price How does a producer know, in general, whether or not its business will be profitable? How does a producer know, in general, whether or not its business will be profitable? Need to compare the market price to the producer’s minimum average total cost Need to compare the market price to the producer’s minimum average total cost

Profitability and the Market Price MC ATC MR= P C A Y Market Price = $ $14.67 Price, cost of bushel Quantity of tomatoes (bushels)

Profitability and the Market Price Minimum average total cost of a price- taking firm is its break-even price Minimum average total cost of a price- taking firm is its break-even price – The price at which it earns zero profit – At firm will earn positive profit when the market price is above the break-even price and it will suffer losses when the market price is below the break-even price

Profitability and the Market Price Rules determining whether a producer of a good is profitable depends on a comparison of the market price of the good to the producer’s break-even price: Rules determining whether a producer of a good is profitable depends on a comparison of the market price of the good to the producer’s break-even price: 1.Whenever market price exceeds minimum average total cost, 2.Whenever the market price equals minimum average total cost, 3.Whenever market price is less than minimum average total cost,