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

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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 1- 9 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-9 A Numerical Example LaborTotal OutputExtra Output of the Group 00 1100 2317217 3500183 4610110 570090 677070 783060 887040 990030 131000

10. 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

11. 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

12. 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

13. 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

14. 1- 14 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-14 Numerical Example OutputTVCTFCTCMC*ATCAVCAFC 008500 1002500850011000251102585 200380085001230013621943 300480085001330010441628 400600085001450012361521 500750085001600015321517 600950085001800020301614 7001250085002100030 1812 8001700085002550045322110.6 900225008500310005534259.4 1000325008500410001004132.58.5 * MC is per 100

15. 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

16. 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

17. 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

18. 1- 18 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-18 Numerical Example For the Many Competitors Case QPTRMR* 0450 100454,50045 200459,00045 3004513,50045 4004518,00045 5004522,50045 6004527,00045 7004531,50045 8004536,00045 9004540,50045 10004545,00045 * MR is per 100

19. 1- 19 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-19 Numerical Example For the No Competitors Case QPTRMR* 0750 100707,00070 2006513,00060 3006018,00050 4005522,00040 5005025,00030 6004527,00020 7004028,00010 8003528,0000 9003027,000-10 10002525,000-20

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

21. 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

22. 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).

23. 1- 23 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-23 Numerical Example of Profit Maximization With Many Competitors QPTRTCMRMCProfit 04508,500-8,500 100454,50011,0004525-6,500 200459,00012,3004513-3,300 3004513,50013,3004510200 4004518,00014,50045123,500 5004522,50016,00045156,500 6004527,00018,00045209,000 7004531,50021,000453010,500 8004536,00025,50045 10,500 9004540,50031,00045559,500 10004545,00041,00045754,000

24. 1- 24 ©2012 The McGraw-Hill Companies, All Rights ReservedMcGraw-Hill/Irwin 4-24 Numerical Example of Profit Maximization With No Competitors QPTRTCMRMCProfit 07508,500-8,500 100707,00011,0007025-6,500 2006513,00012,3006013-3,300 3006018,00013,3005010200 4005522,00014,50040123,500 5005025,00016,00030156,500 6004527,00018,00020 9,000 7004028,00021,00010307,000 8003528,00025,5000452,500 9003027,00031,000-1055-4,000 10002525,00041,000-2075-16,000