McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 04 Firm Production, Cost, and Revenue

1- 2 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-2 Chapter Outline Production Costs Revenue Maximizing Profit

1- 3 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-3 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: the money that comes into the firm from the sale of their goods

1- 4 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-4 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

1- 5 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-5 Production Production Function: a graph which shows how many resources we need to produce various amounts of output Cost Function: a graph which shows how much various amounts of production cost

1- 6 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-6 Inputs to Production Fixed Inputs: resources that you cannot change Variable Inputs: resources that can be easily changed

1- 7 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-7 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

1- 8 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-8 Figure 1 The Production Function Output Workers Production Function A B C D

1- 9 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-9 A Numerical Example LaborTotal OutputExtra Output of the Group

1- 10 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-10 Costs Fixed Costs: costs of production that we cannot change Variable Costs: costs of production that we can change

1- 11 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-11 Figure 2 The Total Cost Function Output Total Cost Total Cost Function A B C D

1- 12 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-12 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

1- 13 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-13 Figure 3 Marginal Cost, Average Total, Average Variable, and Average Fixed Cost P Q MC ATC AVC AFC

1- 14 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-14 Numerical Example OutputTVCTFCTCMC*ATCAVCAFC * MC is per 100

1- 15 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-15 Revenue Marginal Revenue: additional revenue the firm receives from the sale of each unit

1- 16 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-16 Figure 4 Setting the Price When There are Many Competitors Our Firm P Market for Memory P D S P* P*=Marginal Revenue

1- 17 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-17 Figure 5 Marginal Revenue When there are No Competitors MR Market for Memory P D

1- 18 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-18 Numerical Example For the Many Competitors Case QPTRMR* , , , , , , , , , ,00045 * MR is per 100

1- 19 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-19 Numerical Example For the No Competitors Case QPTRMR* , , , , , , , , , ,000-20

1- 20 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-20 Maximizing Profit We assume that firms wish to maximize profits

1- 21 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-21 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

1- 22 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-22 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).

1- 23 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-23 Numerical Example of Profit Maximization With Many Competitors QPTRTCMRMCProfit 04508,500-8, ,50011, , ,00012, , ,50013, ,00014, , ,50016, , ,00018, , ,50021, , ,00025, , ,50031, , ,00041, ,000

1- 24 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-24 Numerical Example of Profit Maximization With No Competitors QPTRTCMRMCProfit 07508,500-8, ,00011, , ,00012, , ,00013, ,00014, , ,00016, , ,00018, , ,00021, , ,00025, , ,00031, , ,00041, ,000