Cost, Revenue, and Profit Maximization Econ 10/2

Warm Up Pretend you own a local burger joint. What are your potential costs?

Measures of Cost Cost of inputs influences production decisions In order to make these decisions easier, cost is divided into categories Fixed Costs: the cost that a business incurs even when production is zero or a lot AKA overhead Does not change Ex. Salaries for executives, rent payments, property taxes

Measures of Costs Variable Costs: a cost that changes when the rate of operation or output changes Ex. Electric power, workers wages, raw materials If you are making more, the costs are more Total Costs: the sum of all the fixed and variable costs Marginal Costs: the extra cost incurred when a business produces one additional unit A per unit increase in variable costs

Applying Cost Principles Gas Station– many pumps, one attendant High fixed costs (the land, pumps, tanks, taxes, licensing fees) Lower variable costs (one employee, electricity, gas sold) Able to operate 24-7 Amazon or other “e-commerce businesses” Lower fixed costs (storage centers, software does a lot of the labor) Also able to operate 24-7

Measures of Revenue Total Revenue: quantity times price Marginal Revenue: extra revenue from producing and selling one more good Ex. T-shirts. If my business has no workers, I get no output and therefore no revenue When I hire the first worker they make 7 shirts and $105 is earned (revenue). That means each shirt added $15 and $15 is the marginal revenue of having one more worker Marginal revenue often starts high and decreases as more is produced

Marginal Analysis Marginal Analysis: a type of cost-benefit decision making that compares the extra benefits to the extra costs When marginal costs are less than marginal revenue, more variable inputs should be hired to expand output Profit-Maximizing quantity of output is when marginal cost equals marginal revenue

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