Chapter 7

Consider this short-run cost data for a firm. Can you fill in the missing columns? And get all the curves? workersTPTVC AVCMCMP TFC TCAFCATC 00$0$ $400$ $800$ $1,200$ $1,600$ $2,000$ $2,400$ $2,800$ $3,200$ $3,600$ $4,000$600

TC

TFC

TC TC=TVC+TFC TFC is constant at $600 and TC will be parallel to TVC, but $600 greater at all levels of TP. The shapes of TC and TVC curves are determined by diminishing marginal returns. –TVC increases as TP increases, however the TVC curve is not a straight line but gets steeper as TP increases. Why? –The next worker hired generates less TP than before while the cost remains the same, there fore the same increase in TP, TVC increases more.

MC of each unit of Product (TC2-TC1)/(TP2-TP1)

MC of each unit of Product TPTVCTFCTCMC 0$0 $600 $ $400 $600 $1,000 $20 44$800 $600 $1,400 $17 75$1,200 $600 $1,800 $13 102$1,600 $600 $2,200 $15 123$2,000 $600 $2,600 $19 137$2,400 $600 $3,000 $29 146$2,800 $600 $3,400 $44 150$3,200 $600 $3,800 $ $3,600 $600 $4,200 $ $4,000 $600 $4,

Minimum MC

MC & MP MP=TP2-TP1

MC & MP TPTVCTFCTCMCMP 0$0 $600 $600 20$400 $600 $1,000 $ $800 $600 $1,400 $ $1,200 $600 $1,800 $ $1,600 $600 $2,200 $ $2,000 $600 $2,600 $ $2,400 $600 $3,000 $ $2,800 $600 $3,400 $ $3,200 $600 $3,800 $ $3,600 $600 $4,200 $ $4,000 $600 $4,600 0

MC & MP Clearly, as MP initially rises MC falls; MC reaches it’s minimum when MP at it’s maximum; MC rises as MP declines. MC is a mirror image of MP MC is determined by diminishing marginal returns.

AC

AFC TPTVCTFCTCMCMPAFC 0$0 $600 $600 20$400 $600 $1,000 $ $800 $600 $1,400 $ $1,200 $600 $1,800 $ $1,600 $600 $2,200 $ $2,000 $600 $2,600 $ $2,400 $600 $3,000 $ $2,800 $600 $3,400 $ $3,200 $600 $3,800 $ $3,600 $600 $4,200 $ $4,000 $600 $4,

AVC TPTVCTFCTCMCMPAFCAVC 0$0 $600 $600 20$400 $600 $1,000 $ $800 $600 $1,400 $ $1,200 $600 $1,800 $ $1,600 $600 $2,200 $ $2,000 $600 $2,600 $ $2,400 $600 $3,000 $ $2,800 $600 $3,400 $ $3,200 $600 $3,800 $ $3,600 $600 $4,200 $ $4,000 $600 $4,

ATC TPTVCTFCTCMCMPAFCAVCATC 0$0 $600 $600 20$400 $600 $1,000 $ $800 $600 $1,400 $ $1,200 $600 $1,800 $ $1,600 $600 $2,200 $ $2,000 $600 $2,600 $ $2,400 $600 $3,000 $ $2,800 $600 $3,400 $ $3,200 $600 $3,800 $ $3,600 $600 $4,200 $ $4,000 $600 $4,

Minimizing ATC Q* level of output that minimizes the average costs for this particular plant size.

Summary of short-run cost curves AVC is always less than ATC (difference is AFC) MC intersects AVC and ATC at their minimum points. –Because when MC AVC it causes AVC to rise. –The same reason also applies to ATC curve. The short-run means that a firm has a fixed input, usually it’s plant size. –Q* the level of output that minimizes ATC for the particularly plant size. TP<Q* means the plant is UNDERUTILIZED, that is why TC decline TP>Q* means the plant is OVERUTILIZED,and as the plant gets close to it’s production limit AC rise very rapidly

Output Decisions Question: How can we use what we know about production technology, costs, and competitive markets to make output decisions?

Reminders... Firms operate in perfectly competitive output markets. In perfectly competitive industries, prices are determined in the market and firms are price takers. The demand curve for the firm is perfectly elastic.

Total and Marginal Revenue Total revenue is amount of revenue the firm takes in from the sale of its product. TR = price x quantity sold Marginal revenue is additional revenue that a firm takes in when it increases output by one additional unit. MR = TR / q

Perfectly elastic demand curve In a perfectly competitive market, the firm’s demand curve is the firm’s marginal revenue curve. $5 Price per unit s d $5 Price per unit D=MR

The firm maximizes profits by producing where MR = MC $5 Price per unit s d $5 Price per unit D=MR MC

Why is q=300 the profit-maximizing level of output for the firm? $5 Price per unit D=MR MC ATC Q

What will be the firm’s profit level at profit-maximizing level of output? $5 Price per unit D=MR MC ATC Q $3.5

Example Table 8.5 Minimizing ATC point : q*=4 Maximizing profit point: 4<q<5 In this question, we chose q=4 –If q>4, we can only choose q=5 which MR=15, MC=20, profit=-5.

Chapter Summary Firm production costs can be fixed or variable, and can be measured in different ways. The law of diminishing returns determines the shape of the short-run cost curves. Minimizing cost of AFC. The profit-maximizing firm will produce output where MC=MR.