PowerPoint PresentationSlide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 33Slide 34Slide 35Slide 36Slide 37Slide 38Slide 39Slide 40Slide 41Slide 42Slide 43Slide 44Slide 45Slide 46Slide 47Slide 48Slide 49Slide 50Slide 51Slide 52Slide 53Slide 54Slide 55Slide 56Slide 57The Firm and Profit MaximizationOverheadsNeoclassical firm - A neoclassical firm is an organization that controls the transformation of inputs (resources it owns or purchases) into outputs (valued products that it sells),and earns the difference between what it receivesin revenue, and what it spends on inputsWe define the production function asf represents the relationship between outputs and inputsxj is the quantity used of the jth input(x1, x2, x3, . . . xn) is the input bundlen is the number of inputs used by the firmy represents outputf(x)maxy[y: (x, y) is an element of the production set]f(x1, x2, x3,) maxy ε P(x)[y]Returns (Profit)The profit from a production plan is the revenue obtainedfrom the plan minus the cost of inputs used to implement itπ p y w1x1 w2x2π p y Σni 1wixiπ Revenue CostsObjectives of the firmWe typically assume that a firm existsin order to make moneyA firm that wants to make money is called a for-profit firm, or a profit maximizing firmThe firm maximizes the returns from thetechnologies it controls taking into account:Given the profit max assumptionThe demand for final consumption goods Opportunities for buying and selling factors / productsThe actions of other firms in the marketThe profit max problemπ(p, w1, w2,)maxx, yp yΣni1wixisuch that y ε P (x)π(p, w1, w2, ) maxypy C(y, w1, w2, )π(p, w1, w2, ) maxxpf (x1, x2, , xn) Σni 1wixiWhat is profit?Profit is revenue minus costs orπ Revenue Costs R CExplicit and implicit costsExplicit costs1. purchase of expendable inputs including labor time2. purchase of capital services (usually rent or lease)Implicit costs1. value of produced expendables(feed for a cattle producer)2. value of services provided by owned capitalincluding financial capital and charges such as implicitrent, depreciation, compensation for operator labor, etc.Accounting profitAccounting costAccounting profit+ depreciation on plant & equipmentexplicit coststotal revenue - accounting costEconomic profitEconomic costEconomic profit+ all implicit costsexplicit coststotal revenue - economic costWhy do we use economic profit?To reflect total costs and revenues for a decisionTo account for all resources used in productionWhy do profits exist?All factors of production receive a paymentExpendables receive their market priceLabor receives wagesLand receives rentCapital receives interestFirm owners receive profitsWhat are profits?Profits are the returns toInnovationRiskproductiondeliverynew productsThe Profit Maximizing Output LevelProfit = Revenue - Cost = R - Cπ Revenue Cost pf (x1, x2, , xn) Σni 1wixi py C(y, w1, w2, ,wn)DemandThe individual demand curve facing a firm tells us, for different prices, the quantity of output that customers will choose to purchase from the firmThe demand curve facing the firm show us themaximum price the firm can charge to sellany given amount of outputExample Inverse Demandsp = 320 - 20yp = $1.85Total RevenueRevenue is the total income that comes from thesale of the output (goods and services) of a givenfirm or production processRevenue R(p, y) py pf (x1, x2, , xn)Y Price FC VC C TR Profit0.00 320 120 0.00 120.00 0 -120.00 1.00 300 120 64.00 184.00 300 116.00 2.00 280 120 130.00 250.00 560 310.00 3.00 260 120 204.00 324.00 780 456.00 4.00 240 120 292.00 412.00 960 548.00 5.00 220 120 400.00 520.00 1100 580.00Y Price FC VC C TR Profit0.00 320 120 0.00 120.00 0 -120.00 1.00 300 120 64.00 184.00 300 116.00 2.00 280 120 130.00 250.00 560 310.00 3.00 260 120 204.00 324.00 780 456.00 4.00 240 120 292.00 412.00 960 548.00 5.00 220 120 400.00 520.00 1100 580.00 6.00 200 120 534.00 654.00 1200 546.00 7.00 180 120 700.00 820.00 1260 440.00 8.00 160 120 904.00 1024.00 1280 256.00 9.00 140 120 1152.00 1272.00 1260 -12.00 10.00 120 120 1450.00 1570.00 1200 -370.00 11.00 100 120 1804.00 1924.00 1100 -824.00 12.00 80 120 2220.00 2340.00 960 -1380.00 14.00 40 120 3262.00 3382.00 560 -2822.00 16.00 0 120 4624.00 4744.00 0 -4744.00Total costCost TC C(x1, x2, , w1, w2, ) Σni 1wixi C(y, w1, w2, )Maximizing profitChoose the level of output wherethe difference between TR and TCis the greatestY Price FC VC C TR Profit0.00 320 120 0.00 120.00 0 -120.00 1.00 300 120 64.00 184.00 300 116.00 2.00 280 120 130.00 250.00 560 310.00 3.00 260 120 204.00 324.00 780 456.00 4.00 240 120 292.00 412.00 960 548.00 5.00 220 120 400.00 520.00 1100 580.00 6.00 200 120 534.00 654.00 1200 546.00 7.00 180 120 700.00 820.00 1260 440.00 8.00 160 120 904.00 1024.00 1280 256.00 9.00 140 120 1152.00 1272.00 1260 -12.00 10.00 120 120 1450.00 1570.00 1200 -370.00 11.00 100 120 1804.00 1924.00 1100 -824.00 12.00 80 120 2220.00 2340.00 960 -1380.00Y Price FC VC C TR Profit0.00 320 120 0.00 120.00 0 -120.00 1.00 300 120 64.00 184.00 300 116.00 2.00 280 120 130.00 250.00 560 310.00 3.00 260 120 204.00 324.00 780 456.00 4.00 240 120 292.00 412.00 960 548.00 5.00 220 120 400.00 520.00 1100 580.00 6.00 200 120 534.00 654.00 1200 546.00 7.00 180 120 700.00 820.00 1260 440.00 8.00 160 120 904.00 1024.00 1280 256.00 9.00 140 120 1152.00 1272.00 1260 -12.00 10.00 120 120 1450.00 1570.00 1200 -370.00 11.00 100 120 1804.00 1924.00 1100 -824.00 12.00 80 120 2220.00 2340.00 960 -1380.00 14.00 40 120 3262.00 3382.00 560 -2822.00 16.00 0 120 4624.00 4744.00 0 -4744.00Marginal cost (MC)Marginal cost is the increment, or addition,to cost that results from producingone more unit of outputMC ΔC(y,w)ΔyΔTC(y,w)Δyy Price FC VC C AFC AVC ATC MC TR MR Profit0.00 320 120 0.00 120.00 0 -120.0064.00 300.00 1.00 300 120 64.00 184.00 120.00 64.00 184.00 300 116.0066.00 260.00 2.00 280 120 130.00 250.00 60.00 65.00 125.00 560 310.0074.00 220.00 3.00 260 120 204.00 324.00 40.00
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