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

Key Topics 1. Cost concepts a. Cash and Non Cash b. Variable and Fixed c. Total: TFC, TVC, TC d. Average: AFC, AVC, ATC, AVC & AP e. Marginal: MC, MC & MP 2. Revenue concepts a. Total b. Marginal 3. Profit concepts a. Profit maximizing output b. Firm & market supply

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

Recent Examples of Firm ‘Cost’ Concerns 1. GM - Spent $5 billion to  costs of producing Saturn cars - Labor costs per car for GM were 2x Toyota’s 2. United, Delta, & other airlines -Southwest’s costs often 50% less 3. Sears, K-Mart, Target -Trying to compete with Walmart on basis of costs 4. Georgia Pacific - Started using ‘thinner’ saws - Less saw dust more rail cars of lumber per year

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

Opportunity Cost Examples ActivityOpportunity Cost Operate own businessLost wages and interest Own and farm landLost rent and interest Buy and operate equipment Lost interest and rent

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

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

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

Cost Tables See7.1, 7.2, 7.3, 7.4

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

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

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

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.

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.

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

Q. True or False? Fixed costs do not affect the profit- maximizing level of output? A. 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.

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

Q. Should a firm ‘shut down’ in SR? A. 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