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

Output, Price, and Profit:Output, Price, and Profit:The Importance of Marginal The Importance of Marginal

AnalysisAnalysis

Asst. Prof. Dr. Serdar AYANAsst. Prof. Dr. Serdar AYAN

Output, Price, and Profit:Output, Price, and Profit:The Importance of Marginal The Importance of Marginal

AnalysisAnalysis

Asst. Prof. Dr. Serdar AYANAsst. Prof. Dr. Serdar AYAN

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Fixed CostsTotal Fixed Costs

Average Fixed Costs =Total Fixed Costs

Quantity

Variable CostsTotal Variable Costs

Average Variable Costs =Total Variable Costs

Quantity

SHORT-RUN PRODUCTION COSTS

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Total Cost= Total Fixed + Variable Costs

Average Total Cost =Total Costs

Quantity

Marginal CostTotal Variable Costs

Marginal Cost =Change in Total Costs

Change in Quantity

SHORT-RUN PRODUCTION COSTS

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

Marginal Cost = MC

Total Fixed Costs = TFCTotal Variable Costs = TVC

Average Variable Costs = AVC

Total Costs = TC

Average Total Costs = ATC

Average Fixed Costs = AFC

Summary of DefinitionsSHORT-RUN PRODUCTION COSTS

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

SHORT-RUN COSTS GRAPHICALLY

Quantity

Cos

ts (

doll

ars)

TC

TVC

TFC

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

LONG-RUN PRODUCTION COSTS

Un

it C

osts

Output

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

LONG-RUN PRODUCTION COSTS

The Long-run ATC just “envelopes”all of the short-run ATC curves

Un

it C

osts

Output

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

LONG-RUN PRODUCTION COSTS

Un

it C

osts

Output

Long-run ATC

Copyright© 2003 Southwestern/Thomson Learning All rights reserved.

ECONOMIES ANDDISECONOMIES OF SCALE

Un

it C

osts

Output

Long-run ATC

Economiesof scale

Diseconomiesof scale

Constant returnsto scale

Price and Quantity: One Decision, Not TwoPrice 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.

FIGURE 7-1 Demand Curve for Al’s Garages

FIGURE 7-1 Demand Curve for Al’s Garages

.

15

25

16

D

D

Profit maximum

5

5

Output, Garages Marketed per Year

Pri

ce p

er G

arag

e (t

ho

usa

nd

s $)

10 9 8 7 6 4 3 2 1 0

10

20 19

22

26

30

35

i h

g

e f

d c

b a

j

Total ProfitTotal 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

Total ProfitTotal 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.

TABLE 7-1 Demand for Al’s Garages

TABLE 7-1 Demand for Al’s Garages

FIGURE 7-2 Total Revenue Curve for Al’s Garages

FIGURE 7-2 Total Revenue Curve for Al’s Garages

TR

A

B

C

D E

F G H I

J

5

To

tal R

even

ue

per

Yea

r (t

ho

usa

nd

s $)

Output, Garages Sold per Year

10 9 8 7 6 4 3 2 1 0

20

40

60

80

100

120

140

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

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

FIGURE 7-3 (a) Cost Curves for Al’s Garages

FIGURE 7-3 (a) Cost Curves for Al’s Garages

TC

(a) Total Cost Output, Garages per Year

5

To

tal

Co

st p

er Y

ear

(th

ou

san

ds

$)

10 9 8 7 6 4 3 2 1 0

20

40

60

200

180

160

140

120

100

80

FIGURE 7-3 (b) Cost Curves for Al’s Garages

FIGURE 7-3 (b) Cost Curves for Al’s Garages

(b) Average Cost Output, Garages per Year

5

Ave

rag

e C

os

t p

er G

arag

e (

tho

usa

nd

s $)

10 9 8 7 6 4 3 2 1 0

5

10

15

45

40

35

30

25

20 AC

FIGURE 7-3 (c) Cost Curves for Al’s Garages

FIGURE 7-3 (c) Cost Curves for Al’s Garages

MC

(c) Marginal Cost Output, Garages per Year

5

Mar

gin

al

Co

st p

er A

dd

ed G

arag

e (t

ho

usa

nd

s $

)

10 9 8 7 6 4 3 2 1 0

5

10

15

45

50

40

35

30

25

20

Total ProfitTotal 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.

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

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

.

Marginal Analysis and Maximization of Total ProfitMarginal 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.

FIGURE 7-4 (a) Profit Maximization

FIGURE 7-4 (a) Profit Maximization

TC

TR

22,000

Profit

(a) Total Revenue. Total Cost Output, Garages per Year

5 To

tal R

even

ue,

To

tal C

ost

per

Yea

r (t

ho

usa

nd

s $)

10 9 8 7 6 4 3 2 1 0

200

180

160

140

120

100

80

60

40

20

74 B

96 A

FIGURE 7-4 (b) Profit Maximization

FIGURE 7-4 (b) Profit Maximization

5

(b) Total Profit Output, Garages per Year

Total profit

F

D

E C

10 9 8 7 6 4 3 2 1

–80

–60

–40

–20

0

20

40

To

tal

Pro

fit

pe

r Y

ea

r (t

ho

us

an

ds

$)

M 34

Marginal Analysis and Maximization of Total ProfitMarginal 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

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

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

FIGURE 7-5(a) Profit Maxim: Another Graphical Interpretation

FIGURE 7-5(a) Profit Maxim: Another Graphical Interpretation

Output, Garages per Year (a) Marginal Revenue and Marginal Cost

5

MR

an

d M

C p

er

Gar

age

pe

r Y

ear

(th

ou

san

ds

$)

10 9 8 7 6 4 3 2 1

–10

0

10

20

30

40

50

MR

MC

E

Marginal Analysis and Maximization of Total ProfitMarginal 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.

Logic of Marginal Analysis & MaximizationLogic 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.

MARGINAL ANALYSISMARGINAL ANALYSIS

Q AR TR TC TP MR MC

0 2

1 15 9

2 12.5 14

3 11 21

4 10 32

5 9 45

6 8 60

Q AR TR TC TP MR MC

0 2

1 15 9

2 12.5 14

3 11 21

4 10 32

5 9 45

6 8 60