Chapter Outline
Chapter 4
Firm Production, Cost, and
Revenue
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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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•
•
•
•
Production
Costs
Revenue
Profit and Profit Maximization
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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
D
C
B
A
Workers
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A Numerical Example
Labor
Total Output
0
100
317
500
0
1
2
3
Extra Output of the Group
100
217
183
4
5
6
7
8
610
700
770
830
870
110
90
70
60
40
9
13
900
1000
30
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D
Total Cost Function
C
B
A
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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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Cost Concepts
Figure 2 The Total Cost Function
Total
Cost
Production
Function
• 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
Output
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2
Figure 3 Marginal Cost, Average Total,
Average Variable, and Average Fixed Cost
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
P
MC
Numerical Example
ATC
AVC
AFC
Q
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300
4800
400
6000
500
7500
600
9500
700 12500
8500
8500
8500
8500
8500
13300
14500
16000
18000
21000
10
12
15
20
30
44
36
32
30
30
16
15
15
16
18
28
21
17
14
12
800 17000
900 22500
1000 32500
8500
8500
8500
25500
31000
41000
45
55
100
32
34
41
21
25
32.5
10.6
9.4
8.5
* MC is per 100
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Figure 4 Setting the Price
When There are Many Competitors
Revenue
P
P
• Marginal Revenue : additional revenue
the firm receives from the sale of each
unit
S
P*
P*=Marginal Revenue
D
Market for Memory
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Figure 5 Marginal Revenue
When there are No Competitors
P
MR
D
Market for Memory
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Our Firm
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Numerical Example
For the Many Competitors Case
Q
0
100
200
P
45
45
45
TR
0
4,500
9,000
MR*
300
400
500
600
700
45
45
45
45
45
13,500
18,000
22,500
27,000
31,500
45
45
45
45
45
800
900
1000
* MR is per 100
45
45
45
36,000
40,500
45,000
45
45
45
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45
45
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Numerical Example For the
No Competitors Case
Maximizing Profit
Q
0
100
200
300
P
75
70
65
60
TR
0
7,000
13,000
18,000
MR*
400
500
600
700
800
55
50
45
40
35
22,000
25,000
27,000
28,000
28,000
40
30
20
10
0
900
1000
30
25
27,000
25,000
-10
-20
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70
60
50
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• We assume that firms wish to maximize
profits
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Rules of Production
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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• 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
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Numerical Example of Profit Maximization
With No Competitors
Q
0
P
45
TR
0
TC
8,500
MR
MC
Profit
-8,500
Q
0
P
75
TR
0
TC
8,500
MR
MC
Profit
-8,500
100
200
300
400
500
45
45
45
45
45
4,500
9,000
13,500
18,000
22,500
11,000
12,300
13,300
14,500
16,000
45
45
45
45
45
25
13
10
12
15
-6,500
-3,300
200
3,500
6,500
100
200
300
400
500
70
65
60
55
50
7,000
13,000
18,000
22,000
25,000
11,000
12,300
13,300
14,500
16,000
70
60
50
40
30
25
13
10
12
15
-6,500
-3,300
200
3,500
6,500
600
700
800
900
1000
45
45
45
45
45
27,000
31,500
36,000
40,500
45,000
18,000
21,000
25,500
31,000
41,000
45
45
45
45
45
20
30
45
55
75
9,000
10,500
10,500
9,500
4,000
600
700
800
900
1000
45
40
35
30
25
27,000
28,000
28,000
27,000
25,000
18,000
21,000
25,500
31,000
41,000
20
10
0
-10
-20
20
30
45
55
75
9,000
7,000
2,500
-4,000
-16,000
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4