1. CH7 : Output, Price, and Profit : The Importance of Marginal Analysis Asst. Prof. Dr. Serdar AYAN

2. Fixed Costs Total Fixed Costs Average Fixed Costs = Total Fixed Costs Quantity Variable Costs Total Variable Costs Average Variable Costs = Total Variable Costs Quantity SHORT-RUN PRODUCTION COSTS

3. 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 SHORT-RUN PRODUCTION COSTS

4. Marginal Cost = MC Total Fixed Costs = TFC Total Variable Costs = TVC Average Variable Costs = AVC Total Costs = TC Average Total Costs = ATC Average Fixed Costs = AFC Summary of Definitions SHORT-RUN PRODUCTION COSTS

5. SHORT-RUN COSTS GRAPHICALLY Quantity Costs (dollars) TC TVC TFC

6. LONG-RUN PRODUCTION COSTS Unit Costs Output

7. LONG-RUN PRODUCTION COSTS The Long-run ATC just “envelopes” all of the short-run ATC curves Unit Costs Output

8. LONG-RUN PRODUCTION COSTS Unit Costs Output Long-run ATC

9. ECONOMIES AND DISECONOMIES OF SCALE Unit Costs Output Long-run ATC Economies of scale Diseconomies of scale Constant returns to scale

10. 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. ●Firms face a demand curve on which price and quantity are related. ●They can choose either price or quantity, but not both.

11. FIGURE 7-1 Demand Curve for Al’s Garages. 15 25 16 D D Profit maximum 5 5 Output, Garages Marketed per Year Price per Garage (thousands $) 10987643210 20 19 22 26 30 35 i h g e f d c b a j

12. Total Profit ●Simplifying assumption: maximum total profit is the firm’s goal. ●Total profit = total revenue - total costs ●Simplifying assumption: maximum total profit is the firm’s goal. ●Total profit = total revenue - total costs

13. 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. ●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.

14. TABLE 7-1 Demand for Al’s Garages

15. FIGURE 7-2 Total Revenue Curve for Al’s Garages TR A B C D E F G H I J 5 Total Revenue per Year (thousands $) Output, Garages Sold per Year 10987643210 20 40 60 80 100 120 140

16. TABLE 7-2 Al’s Total, Average, and Marginal Costs

17. FIGURE 7-3 (a) Cost Curves for Al’s Garages TC (a) Total Cost Output, Garages per Year 5 Total Cost per Year (thousands $) 10987643210 20 40 60 200 180 160 140 120 100 80

18. FIGURE 7-3 (b) Cost Curves for Al’s Garages (b) Average Cost Output, Garages per Year 5 Average Cost per Garage (thousands $) 10987643210 5 15 45 40 35 30 25 20 AC

19. FIGURE 7-3 (c) Cost Curves for Al’s Garages MC (c) Marginal Cost Output, Garages per Year 5 Marginal Cost per Added Garage (thousands $) 10987643210 5 15 45 50 40 35 30 25 20

20. Total Profit ●Maximization of Total Profits ♦Profits typically increase with output, then fall. ♦Some intermediate level of output, therefore, generates the maximum profit. ●Maximization of Total Profits ♦Profits typically increase with output, then fall. ♦Some intermediate level of output, therefore, generates the maximum profit.

21. TABLE 7-3 TR, Costs, and Profit for Al’s Garages.

22. 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. ●Marginal profit is the slope of the total profit curve. ●Profit is at a maximum when the marginal profit is zero.

23. FIGURE 7-4 (a) Profit Maximization TC TR 22,000 Profit (a) Total Revenue. Total Cost Output, Garages per Year 5 Total Revenue, Total Cost per Year (thousands $) 10987643210 200 180 160 140 120 100 80 60 40 20 74 B 96 A

24. FIGURE 7-4 (b) Profit Maximization 5 (b) Total Profit Output, Garages per Year Total profit F D E C 10 9 876432 1 –80 –60 –40 –20 0 20 40 Total Profit per Year (thousands $) M 34

25. 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 ●Optimum Marginal Revenue and Marginal Cost ♦If MR > MC,  production   profits ♦If MR < MC,  production   profits ●Profit maximizing level out output: MR = MC

26. TABLE 7-4 Al’s Marginal Revenue and Marginal Cost

27. FIGURE 7-5(a) Profit Maxim: Another Graphical Interpretation Output, Garages per Year (a) Marginal Revenue and Marginal Cost 5 MR and MC per Garage per Year (thousands $) 1098764321 –10 0 10 20 30 40 50 MR MC E

28. 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. ●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.

29. 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. ●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.