Slide 1CHAPTER OUTLINEBasic DefinitionsEconomic vs. Accounting CostProductionInputs to ProductionConcepts in ProductionFigure 1 The Production FunctionA Numerical ExampleCostsFigure 2 The Total Cost FunctionCost ConceptsSlide 13Numerical ExampleRevenueFigure 4 Setting the Price When There are Many CompetitorsFigure 5 Marginal Revenue When there are No CompetitorsNumerical Example For the Many Competitors CaseNumerical Example For the No Competitors CaseMaximizing ProfitMarket FormsRules of ProductionNumerical Example of Profit Maximization With Many CompetitorsNumerical Example of Profit Maximization With No Competitors4-1©2015 McGraw-Hill Education. All Rights Reserved ©2015 McGraw-Hill Education. All Rights Reserved Chapter 4Firm Production, Cost, and Revenue4-2©2015 McGraw-Hill Education. All Rights Reserved CHAPTER OUTLINE•Production•Costs•Revenue•Profit and Profit Maximization4-3©2015 McGraw-Hill Education. All Rights Reserved 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 goods4-4©2015 McGraw-Hill Education. All Rights Reserved 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 business4-5©2015 McGraw-Hill Education. All Rights Reserved 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 cost4-6©2015 McGraw-Hill Education. All Rights Reserved Inputs to Production•Fixed Inputs: resources that you cannot change•Variable Inputs : resources that can be easily changed4-7©2015 McGraw-Hill Education. All Rights Reserved 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 rate4-8©2015 McGraw-Hill Education. All Rights Reserved Figure 1 The Production FunctionOutputWorkersProduction FunctionABCD4-9©2015 McGraw-Hill Education. All Rights Reserved A Numerical ExampleLabor Total Output Extra Output of the Group0 01 100 1002 317 2173 500 1834 610 1105 700 906 770 707 830 608 870 409 900 3013 10004-10©2015 McGraw-Hill Education. All Rights Reserved Costs•Fixed Costs: costs of production that we cannot change•Variable Costs: costs of production that we can change4-11©2015 McGraw-Hill Education. All Rights Reserved Figure 2 The Total Cost FunctionOutputTotal CostTotal Cost FunctionABCD4-12©2015 McGraw-Hill Education. All Rights Reserved 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 production4-13©2015 McGraw-Hill Education. All Rights Reserved Figure 3 Marginal Cost, Average Total, Average Variable, and Average Fixed CostPQMCATCAVCAFC4-14©2015 McGraw-Hill Education. All Rights Reserved Numerical ExampleOutputTVC TFC TC MC* ATC AVC AFC0 0 8500 8500100 2500 8500 1100025 110 25 85200 3800 8500 1230013 62 19 43300 4800 8500 1330010 44 16 28400 6000 8500 1450012 36 15 21500 7500 8500 1600015 32 15 17600 9500 8500 1800020 30 16 14700 125008500 2100030 30 18 12800 170008500 2550045 32 21 10.6900 225008500 3100055 34 25 9.41000 325008500 41000100 41 32.5 8.5* MC is per 1004-15©2015 McGraw-Hill Education. All Rights Reserved Revenue•Marginal Revenue : additional revenue the firm receives from the sale of each unit4-16©2015 McGraw-Hill Education. All Rights Reserved Figure 4 Setting the Price When There are Many CompetitorsOur FirmPMarket for MemoryPDSP*P*=Marginal Revenue4-17©2015 McGraw-Hill Education. All Rights Reserved Figure 5 Marginal Revenue When there are No Competitors MRMarket for MemoryPD4-18©2015 McGraw-Hill Education. All Rights Reserved Numerical Example For the Many Competitors CaseQ P TR MR*0 45 0100 45 4,500 45200 45 9,000 45300 45 13,500 45400 45 18,000 45500 45 22,500 45600 45 27,000 45700 45 31,500 45800 45 36,000 45900 45 40,500 451000 45 45,000 45* MR is per 1004-19©2015 McGraw-Hill Education. All Rights Reserved Numerical Example For the No Competitors CaseQ P TR MR*0 75 0100 70 7,000 70200 65 13,000 60300 60 18,000 50400 55 22,000 40500 50 25,000 30600 45 27,000 20700 40 28,000 10800 35 28,000 0900 30 27,000 -101000 25 25,000 -204-20©2015 McGraw-Hill Education. All Rights Reserved Maximizing Profit•We assume that firms wish to maximize profits4-21©2015 McGraw-Hill Education. All Rights Reserved 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 good4-22©2015 McGraw-Hill Education. All Rights Reserved 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).4-23©2015 McGraw-Hill Education. All Rights Reserved Numerical Example of Profit Maximization With Many CompetitorsQ P TR TC MR MC Profit0 45 0 8,500 -8,500100 45 4,500 11,00045 25 -6,500200 45 9,000 12,30045 13 -3,300300 45 13,500 13,30045 10 200400 45 18,000 14,50045 12 3,500500 45 22,500 16,00045 15 6,500600 45 27,000 18,00045 20 9,000700 45 31,500 21,00045 30 10,500800 45 36,000 25,50045 45 10,500900 45 40,500 31,00045 55 9,5001000 45 45,000 41,00045 75 4,0004-24©2015 McGraw-Hill Education. All Rights Reserved Numerical Example of Profit Maximization With No CompetitorsQ P TR TC MR MC Profit0 75 0 8,500 -8,500100 70 7,000 11,00070 25 -6,500200 65 13,000 12,30060 13 -3,300300 60 18,000 13,30050 10 200400 55 22,000 14,50040 12 3,500500 50 25,000 16,00030 15 6,500600 45 27,000 18,00020 20 9,000700 40 28,000 21,00010 30 7,000800 35 28,000 25,5000 45 2,500900 30 27,000 31,000-10 55 -4,000100025 25,000 41,000-20 75