Chapter Outline

• Production
• Costs
• Revenue
• Maximizing Profit

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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

Production
C Function

B
A

Workers
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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

Total
Cost
D Total Cost Function

Output
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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
P

MC
ATC

AVC

AFC

Q
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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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 Setting the Price
When There are Many Competitors
P P
S

P*
P*=Marginal Revenue

Market for Stocks Our Firm

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 Figure 5 Marginal Revenue
When there are No Competitors
P

MR D

Market for Iphone

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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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