# Isues in economics today 6th by guell chapter04

Chapter 04
Firm
Production,
Cost, and
Revenue

McGraw-Hill/Irwin

Chapter Outline

Production
Costs
Revenue
Maximizing Profit

McGraw-Hill/Irwin

4-2
1-2

Basic Definitions
• Profit: The money that
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
McGraw-Hill/Irwin

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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
• Accounting Cost: Only those
costs that must be explicitly
paid by the owner of a business
McGraw-Hill/Irwin

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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
McGraw-Hill/Irwin

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Inputs to Production
• Fixed Inputs: resources that
you cannot change
• Variable Inputs: resources
that can be easily changed

McGraw-Hill/Irwin

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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
increases production but does
so at a decreasing rate
McGraw-Hill/Irwin

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Figure 1 The Production Function
Output

D

C

A

Production
Function

B

Workers
McGraw-Hill/Irwin

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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

McGraw-Hill/Irwin

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Costs
• Fixed Costs: costs of
production that we cannot
change
• Variable Costs: costs of
production that we can
change

McGraw-Hill/Irwin

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Figure 2 The Total Cost Function
Total
Cost
D

Total Cost Function

C
B

A

Output
McGraw-Hill/Irwin

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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

McGraw-Hill/Irwin

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Figure 3 Marginal Cost, Average Total,
Average Variable, and Average Fixed Cost
P
MC

ATC
AVC

AFC

Q
McGraw-Hill/Irwin

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Numerical Example
Outpu TVC
t

TFC

TC

MC*

ATC

AVC

AFC

0

0

8500

8500

100

2500

8500

1100
0

25

110

25

85

200

3800

8500

1230
0

13

62

19

43

300

4800

8500

1330
0

10

44

16

28

400

6000

8500

1450
0

12

36

15

21

500

7500

8500

1600
0

15

32

15

17

600

9500

8500

1800
0

20

30

16

14

McGraw-Hill/Irwin
700
1250

8500

2100

30

30

18

4-14
1-14
12

* MC is per 100

Revenue
• Marginal Revenue:
receives from the sale of each
unit

McGraw-Hill/Irwin

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Figure 4 Setting the Price
When There are Many Competitors
P

P

S

P*

P*=Marginal Revenue

D

Market for Memory
McGraw-Hill/Irwin

Our Firm

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Figure 5 Marginal Revenue
When there are No Competitors
P

MR

D

Market for Memory
McGraw-Hill/Irwin

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Numerical Example
For the Many Competitors Case
Q

P

TR

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

45

45,000

45

1000
* MR is per 100
McGraw-Hill/Irwin

MR*

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Numerical Example For the
No Competitors Case
Q

P

TR

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

McGraw-Hill/Irwin

MR*

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Maximizing Profit
• We assume that firms wish to
maximize profits

McGraw-Hill/Irwin

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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
McGraw-Hill/Irwin

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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 (PMcGraw-Hill/Irwin

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Numerical Example of Profit Maximization
With Many Competitors
Q

P

TR

TC

0

45

0

8,500

100

45

4,500

11,00
0

45

25

-6,500

200

45

9,000

12,30
0

45

13

-3,300

300

45

13,500

13,30
0

45

10

200

400

45

18,000

14,50
0

45

12

3,500

500

45

22,500

16,00
0

45

15

6,500

600

45

27,000

18,00
0

45

20

9,000

21,00

45

30

10,500

700
45
31,500
McGraw-Hill/Irwin

MR

MC

Profit
-8,500

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Numerical Example of Profit Maximization
Q

P

0

With No Competitors
TR

TC

75

0

8,500

100

70

7,000

11,00
0

70

25

-6,500

200

65

13,000

12,30
0

60

13

-3,300

300

60

18,000

13,30
0

50

10

200

400

55

22,000

14,50
0

40

12

3,500

500

50

25,000

16,00
0

30

15

6,500

600

45

27,000

18,00
0

20

20

9,000

700

40

28,000

McGraw-Hill/Irwin

MR

MC

Profit
-8,500

21,00
10
30
7,000

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