Asst. Prof. Dr. Serdar AYAN CH7 : Output, Price, and Profit : The Importance of Marginal Analysis Asst. Prof. Dr. Serdar AYAN

SHORT-RUN PRODUCTION COSTS Fixed Costs Total Fixed Costs Average Fixed Costs = Total Fixed Costs Quantity Variable Costs Total Variable Costs Average Variable Costs = Total Variable Costs Quantity

SHORT-RUN PRODUCTION COSTS Total Cost = Total Fixed + Variable Costs Average Total Cost = Total Costs Quantity Marginal Cost Total Variable Costs Marginal Cost = Change in Total Costs Change in Quantity

SHORT-RUN PRODUCTION COSTS Summary of Definitions Total Fixed Costs = TFC Total Variable Costs = TVC Total Costs = TC Average Fixed Costs = AFC Average Variable Costs = AVC Average Total Costs = ATC Marginal Cost = MC

SHORT-RUN COSTS GRAPHICALLY TC TVC Costs (dollars) TFC Quantity

LONG-RUN PRODUCTION COSTS Unit Costs Output

LONG-RUN PRODUCTION COSTS The Long-run ATC just “envelopes” all of the short-run ATC curves Unit Costs Output

LONG-RUN PRODUCTION COSTS Unit Costs Long-run ATC Output

ECONOMIES AND DISECONOMIES OF SCALE Constant returns to scale Diseconomies of scale Unit Costs Long-run ATC Output

Price 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.

FIGURE 7-1 Demand Curve for Al’s Garages 35 D i h g e f d c b a j 30 26 Profit maximum 25 22 20 19 Price per Garage (thousands $) 16 15 10 5 1 2 3 4 5 6 7 8 9 10 Output, Garages Marketed per Year .

Total Profit Simplifying assumption: maximum total profit is the firm’s goal. Total profit = total revenue - total costs

Total 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.

TABLE 7-1 Demand for Al’s Garages

FIGURE 7-2 Total Revenue Curve for Al’s Garages 140 TR A B C D E F G H I J 120 100 80 Total Revenue per Year (thousands $) 60 40 20 1 2 3 4 5 6 7 8 9 10 Output, Garages Sold per Year

TABLE 7-2 Al’s Total, Average, and Marginal Costs

FIGURE 7-3 (a) Cost Curves for Al’s Garages 200 TC 180 160 140 120 Total Cost per Year (thousands $) 100 80 60 40 20 1 2 3 4 5 6 7 8 9 10 Output, Garages per Year (a) Total Cost

FIGURE 7-3 (b) Cost Curves for Al’s Garages 45 40 35 30 25 Average Cost per Garage (thousands $) AC 20 15 10 5 1 2 3 4 5 6 7 8 9 10 Output, Garages per Year (b) Average Cost

FIGURE 7-3 (c) Cost Curves for Al’s Garages 50 MC 45 40 35 30 Marginal Cost per Added Garage (thousands $) 25 20 15 10 5 1 2 3 4 5 6 7 8 9 10 Output, Garages per Year (c) Marginal Cost

Total 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 .

Marginal 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.

FIGURE 7-4 (a) Profit Maximization 200 TC 180 160 140 TR 120 Profit Total Revenue, Total Cost per Year (thousands $) 100 96 A 22,000 80 74 B 60 40 20 1 2 3 4 5 6 7 8 9 10 Output, Garages per Year (a) Total Revenue. Total Cost

FIGURE 7-4 (b) Profit Maximization Total profit F 40 M 34 D E C 20 9 2 3 4 5 6 7 8 10 Total Profit per Year (thousands $) –20 1 –40 –60 –80 Output, Garages per Year (b) Total Profit

Marginal 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

TABLE 7-4 Al’s Marginal Revenue and Marginal Cost

FIGURE 7-5(a) Profit Maxim: Another Graphical Interpretation 50 MC 40 30 MR MR and MC per Garage per Year (thousands $) 20 E 10 1 2 3 4 5 6 7 8 9 10 –10 Output, Garages per Year (a) Marginal Revenue and Marginal Cost

Marginal 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.

Logic 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.