Chapter 4 Firm Production, Cost, and Revenue Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Dec 22, 2015
Chapter 4Firm Production, Cost,
and Revenue
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
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Chapter Outline
• Production• Costs• Revenue• Profit and Profit Maximization
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You Are Here
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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
AB
C
D
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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
A
B
C
D
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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 CostP
Q
MCATC
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
P
Market for Memory
P
D
S
P*P*=Marginal Revenue
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Figure 5 Marginal Revenue When there are No
Competitors
MR
Market for Memory
P
D
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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),
unlessb) the price is less than the average variable cost (P<AVC).
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Numerical Example of Profit Maximization With Many
CompetitorsQ 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 CompetitorsQ 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