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Output, Price, and Profit: The Importance of Marginal Analysis Asst. Prof. Dr. Serdar AYAN. Total Variable Costs. Total Fixed Costs. Average Fixed Costs =. Average Variable Costs =. Quantity. Quantity. SHORT-RUN PRODUCTION COSTS. Fixed Costs. Total Fixed Costs. Variable Costs. - PowerPoint PPT Presentation
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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