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Chapter 2
Chapter 2
OVERVIEW
Economic Optimization Process
Revenue Relations
Cost Relations
Profit Relations
Incremental Concept in Economic Analysis
Chapter 2
KEY CONCEPTS
optimal decision marginal cost
spreadsheet average cost
Equation average cost minimization
dependent variable total profit
independent variable marginal profit
marginal revenue profit maximization rule
revenue maximization breakeven points
cost functions incremental change
short-run cost functions incremental profit
long-run cost functions breakeven point
short run average cost minimization
long run multivariate optimization
total costs constrained optimization
fixed costs Lagrangian technique
variable costs Lagrangian multiplier,
Economic Optimization Process
Optimal Decisions
Best decision produces the result most
consistent with managerial objectives.
Maximizing the Value of the Firm
Produce what customers want.
Meet customer needs efficiently.
Greed vs. Self-interest
Self-indulgence leads to failure.
Customer focus leads to mutual benefit.
2009, 2006 South-Western, a
part of Cengage Learning
Revenue Relations
Price and Total Revenue
Total Revenue = Price Quantity.
Marginal Revenue
Change in total revenue associated with a one-unit
change in output.
Revenue Maximization
Quantity with highest revenue, MR = 0.
Do Firms Really Optimize?
Inefficiency and waste lead to failure.
Optimization techniques are widely employed by
successful firms.
Where do demand equations come
from?
Companies compile data over time on
specific variables. (Time series analysis)
R2 = 0.74
What other independent variables could have been included that probably
would have increased the explanatory power of the model?
- the prices of related goods, per capita income
Based on the regression results, if the price of the good is increased by one
unit, what will be the impact on demand?
- demand would be expected to fall by 45.9 unites
- the positive sign indicates that as the temperature increases so will the
demand for this good. Hence, its more likely to be a product such as Pepsi.
In which coefficients would you have at least 95% confidence that you have a
good estimate of the marginal relationship between the independent variable
and the dependent variable?
- each one for which the estimated coefficient is at least twice as great as the
standard error of the coefficient (P and A; not T)
Predicting Demand given some
economic starting points
One can predict with a 95% confidence of being correct that the demand of this
good next period will lie in the range of 889.50 units to 953.50 units. The 95%
confidence interval would be 921.50 + 2(16). This range is 921.50 + 32 =
953.50 on the upper end and 921.50 32 = 889.50 on the lower end.
What does the coefficient of P
really mean?
- that if the price of the good is increased by one
unit while every other independent variable is held
constant, the demand for this good will fall by 45.9 units.
TC = $8 + 4Q + .5Q2
2009, 2006 South-Western, a
part of Cengage Learning
L. Pantuosco Course Notes
(D)/(/P) = -45.9 (D)/(/A) = 292.5 (D)/(/T) = 17.8
Suppose the independent variables have the values given in part (g).
What impact would there by on demand if the price of the goods were
increased by 1%? - to answer this we need to use the concept
of point price-elasticity of demand:
A firm has the production function: Q =40L .80 K .20. The prices of
labor and capital are $1,000 and $2,000 respectively. What
combination of L and K would produce an output level of 5800 units
at the lowest total cost?
There are two approaches to this problem: (a) the optimal input ratio approach
and (b) the Lagrangian Multiplier Approach.