Professional Assignment 1 -(CLOs covered : CLO 1, CLO 2)

Chap_04.pptx

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Chapter 4 Firm Production, Cost, and Revenue

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CHAPTER OUTLINE

Production

Costs

Revenue

Profit and Profit Maximization

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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

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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

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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

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Inputs to Production

Fixed Inputs: resources that you cannot change

Variable Inputs : resources that can be easily changed

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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

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Figure 1 The Production Function

Output

Workers

Production Function

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A Numerical Example

Labor	Total Output	Extra Output of the Group
0	0
1	100	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

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Costs

Fixed Costs: costs of production that we cannot change

Variable Costs: costs of production that we can change

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Figure 2 The Total Cost Function

Output

Total Cost

Total Cost Function

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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

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Figure 3 Marginal Cost, Average Total, Average Variable, and Average Fixed Cost

ATC

AVC

AFC

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Numerical Example

Output	TVC	TFC	TC	MC*	ATC	AVC	AFC
0	0	8500	8500
100	2500	8500	11000	25	110	25	85
200	3800	8500	12300	13	62	19	43
300	4800	8500	13300	10	44	16	28
400	6000	8500	14500	12	36	15	21
500	7500	8500	16000	15	32	15	17
600	9500	8500	18000	20	30	16	14
700	12500	8500	21000	30	30	18	12
800	17000	8500	25500	45	32	21	10.6
900	22500	8500	31000	55	34	25	9.4
1000	32500	8500	41000	100	41	32.5	8.5

* MC is per 100

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Revenue

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

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Figure 4 Setting the Price When There are Many Competitors

Our Firm

Market for Memory

P*=Marginal Revenue

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Figure 5 Marginal Revenue When there are No Competitors

Market for Memory

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Numerical Example For the Many Competitors Case

Q	P	TR	MR*
0	45	0
100	45	4,500	45
200	45	9,000	45
300	45	13,500	45
400	45	18,000	45
500	45	22,500	45
600	45	27,000	45
700	45	31,500	45
800	45	36,000	45
900	45	40,500	45
1000	45	45,000	45

* MR is per 100

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Numerical Example For the No Competitors Case

Q	P	TR	MR*
0	75	0
100	70	7,000	70
200	65	13,000	60
300	60	18,000	50
400	55	22,000	40
500	50	25,000	30
600	45	27,000	20
700	40	28,000	10
800	35	28,000	0
900	30	27,000	-10
1000	25	25,000	-20

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Maximizing Profit

We assume that firms wish to maximize profits

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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

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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).

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Numerical Example of Profit Maximization With Many Competitors

Q	P	TR	TC	MR	MC	Profit
0	45	0	8,500			-8,500
100	45	4,500	11,000	45	25	-6,500
200	45	9,000	12,300	45	13	-3,300
300	45	13,500	13,300	45	10	200
400	45	18,000	14,500	45	12	3,500
500	45	22,500	16,000	45	15	6,500
600	45	27,000	18,000	45	20	9,000
700	45	31,500	21,000	45	30	10,500
800	45	36,000	25,500	45	45	10,500
900	45	40,500	31,000	45	55	9,500
1000	45	45,000	41,000	45	75	4,000

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Numerical Example of Profit Maximization With No Competitors

Q	P	TR	TC	MR	MC	Profit
0	75	0	8,500			-8,500
100	70	7,000	11,000	70	25	-6,500
200	65	13,000	12,300	60	13	-3,300
300	60	18,000	13,300	50	10	200
400	55	22,000	14,500	40	12	3,500
500	50	25,000	16,000	30	15	6,500
600	45	27,000	18,000	20	20	9,000
700	40	28,000	21,000	10	30	7,000
800	35	28,000	25,500	0	45	2,500
900	30	27,000	31,000	-10	55	-4,000
1000	25	25,000	41,000	-20	75	-16,000

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