1. Chapter 04 Firm Production, Cost, and Revenue

2. Chapter Outline
Production
Costs
Revenue
Maximizing Profit

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

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

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

6. Inputs to Production Fixed Inputs: resources that you cannot change
Variable Inputs: resources that can be easily changed

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

8. Figure 1 The Production Function
Output
Workers D
Production Function C B A

9. A Numerical Example Labor Total Output Extra Output of the Group 1 1001
100 2
317
217 3
500
183 4
610
110 5
700 90 6
770 70 7
830 60 8
870 40 9
900 30 13
1000

10. Costs Fixed Costs: costs of production that we cannot change
Variable Costs: costs of production that we can change

11. Figure 2 The Total Cost Function
Output
Total Cost
Total Cost Function D C B A

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

13. Figure 3 Marginal Cost, Average Total, Average Variable, and Average Fixed CostP Q MC
ATC
AVC
AFC

14. Numerical Example Output TVC TFC TC MC* ATC AVC AFC 8500 100 2500
8500
100
2500
11000 25
110 85
200
3800
12300 13 62 19 43
300
4800
13300 10 44 16 28
400
6000
14500 12 36 15 21
500
7500
16000 32 17
600
9500
18000 20 30 14
700
12500
21000 18
800
17000
25500 45
10.6
900
22500
31000 55 34
9.4
1000
32500
41000 41
32.5
8.5
* MC is per 100

15. Revenue
Marginal Revenue: additional revenue the firm receives from the sale of each unit

16. Figure 4 Setting the Price When There are Many Competitors
Market for Memory P D S
Our Firm P P*
P*=Marginal Revenue

17. Figure 5 Marginal Revenue When there are No Competitors
Market for Memory P D MR

18. Numerical Example For the Many Competitors CaseQ P TR
MR* 45
100
4,500
200
9,000
300
13,500
400
18,000
500
22,500
600
27,000
700
31,500
800
36,000
900
40,500
1000
45,000
* MR is per 100

19. Numerical Example For the No Competitors CaseQ P TR
MR* 75
100 70
7,000
200 65
13,000 60
300
18,000 50
400 55
22,000 40
500
25,000 30
600 45
27,000 20
700
28,000 10
800 35
900
-10
1000 25
-20

20. Maximizing Profit
We assume that firms wish to maximize profits

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

22. Rules of Production A firm should unless
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).

23. Numerical Example of Profit Maximization With Many CompetitorsQ P TR TC MR MC
Profit 45
8,500
-8,500
100
4,500
11,000 25
-6,500
200
9,000
12,300 13
-3,300
300
13,500
13,300 10
400
18,000
14,500 12
3,500
500
22,500
16,000 15
6,500
600
27,000 20
700
31,500
21,000 30
10,500
800
36,000
25,500
900
40,500
31,000 55
9,500
1000
45,000
41,000 75
4,000

24. Numerical Example of Profit Maximization With No CompetitorsQ P TR TC MR MC
Profit 75
8,500
-8,500
100 70
7,000
11,000 25
-6,500
200 65
13,000
12,300 60 13
-3,300
300
18,000
13,300 50 10
400 55
22,000
14,500 40 12
3,500
500
25,000
16,000 30 15
6,500
600 45
27,000 20
9,000
700
28,000
21,000
800 35
25,500
2,500
900
31,000
-10
-4,000
1000
41,000
-20
-16,000