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Asst. Prof. Dr. Serdar AYAN
CH7 : Output, Price, and Profit : The Importance of Marginal Analysis Asst. Prof. Dr. Serdar AYAN
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SHORT-RUN PRODUCTION COSTS
Fixed Costs Total Fixed Costs Average Fixed Costs = Total Fixed Costs Quantity Variable Costs Total Variable Costs Average Variable Costs = Total Variable Costs Quantity
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SHORT-RUN PRODUCTION COSTS
Total Cost = Total Fixed + Variable Costs Average Total Cost = Total Costs Quantity Marginal Cost Total Variable Costs Marginal Cost = Change in Total Costs Change in Quantity
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SHORT-RUN PRODUCTION COSTS Summary of Definitions
Total Fixed Costs = TFC Total Variable Costs = TVC Total Costs = TC Average Fixed Costs = AFC Average Variable Costs = AVC Average Total Costs = ATC Marginal Cost = MC
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SHORT-RUN COSTS GRAPHICALLY
TC TVC Costs (dollars) TFC Quantity
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LONG-RUN PRODUCTION COSTS
Unit Costs Output
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LONG-RUN PRODUCTION COSTS
The Long-run ATC just “envelopes” all of the short-run ATC curves Unit Costs Output
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LONG-RUN PRODUCTION COSTS
Unit Costs Long-run ATC Output
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ECONOMIES AND DISECONOMIES OF SCALE
Constant returns to scale Diseconomies of scale Unit Costs Long-run ATC Output
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Price and Quantity: One Decision, Not Two
Firms face a demand curve on which price and quantity are related. They can choose either price or quantity, but not both.
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FIGURE 7-1 Demand Curve for Al’s Garages
35 D i h g e f d c b a j 30 26 Profit maximum 25 22 20 19 Price per Garage (thousands $) 16 15 10 5 1 2 3 4 5 6 7 8 9 10 Output, Garages Marketed per Year .
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Total Profit Simplifying assumption: maximum total profit is the firm’s goal. Total profit = total revenue - total costs
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Total Profit Total, Average, and Marginal Revenue
Total Revenue = P Q Average Revenue = TR/Q = (P Q)/Q = P Marginal Revenue = total revenue from one more unit of output = TR/ Q. Marginal Cost = total cost from one more unit of output = TC/ Q.
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TABLE 7-1 Demand for Al’s Garages
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FIGURE 7-2 Total Revenue Curve for Al’s Garages
140 TR A B C D E F G H I J 120 100 80 Total Revenue per Year (thousands $) 60 40 20 1 2 3 4 5 6 7 8 9 10 Output, Garages Sold per Year
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TABLE 7-2 Al’s Total, Average, and Marginal Costs
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FIGURE 7-3 (a) Cost Curves for Al’s Garages
200 TC 180 160 140 120 Total Cost per Year (thousands $) 100 80 60 40 20 1 2 3 4 5 6 7 8 9 10 Output, Garages per Year (a) Total Cost
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FIGURE 7-3 (b) Cost Curves for Al’s Garages
45 40 35 30 25 Average Cost per Garage (thousands $) AC 20 15 10 5 1 2 3 4 5 6 7 8 9 10 Output, Garages per Year (b) Average Cost
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FIGURE 7-3 (c) Cost Curves for Al’s Garages
50 MC 45 40 35 30 Marginal Cost per Added Garage (thousands $) 25 20 15 10 5 1 2 3 4 5 6 7 8 9 10 Output, Garages per Year (c) Marginal Cost
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Total Profit Maximization of Total Profits
Profits typically increase with output, then fall. Some intermediate level of output, therefore, generates the maximum profit.
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TABLE 7-3 TR, Costs, and Profit for Al’s Garages
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Marginal Analysis and Maximization of Total Profit
Marginal profit is the slope of the total profit curve. Profit is at a maximum when the marginal profit is zero.
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FIGURE 7-4 (a) Profit Maximization
200 TC 180 160 140 TR 120 Profit Total Revenue, Total Cost per Year (thousands $) 100 96 A 22,000 80 74 B 60 40 20 1 2 3 4 5 6 7 8 9 10 Output, Garages per Year (a) Total Revenue. Total Cost
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FIGURE 7-4 (b) Profit Maximization
Total profit F 40 M 34 D E C 20 9 2 3 4 5 6 7 8 10 Total Profit per Year (thousands $) –20 1 –40 –60 –80 Output, Garages per Year (b) Total Profit
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Marginal Analysis and Maximization of Total Profit
Optimum Marginal Revenue and Marginal Cost If MR > MC, production profits If MR < MC, production profits Profit maximizing level out output: MR = MC
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TABLE 7-4 Al’s Marginal Revenue and Marginal Cost
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FIGURE 7-5(a) Profit Maxim: Another Graphical Interpretation
50 MC 40 30 MR MR and MC per Garage per Year (thousands $) 20 E 10 1 2 3 4 5 6 7 8 9 10 –10 Output, Garages per Year (a) Marginal Revenue and Marginal Cost
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Marginal Analysis and Maximization of Total Profit
Finding the Optimal Price from Optimal Output MR = MC: rule for determining the level of output Demand curve price buyers will pay to purchase that level of output Both output and price are now determined for the profit maximizing firm.
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Logic of Marginal Analysis & Maximization
Application: Fixed Cost and Profit Maximization An increase in fixed costs does not change optimal output or price because it does not affect marginal costs.
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