Economic Optimization Chapter 2

Economic Optimization Process Optimal Decisions Best decision produces the result most consistent with managerial objectives. Maximizing the Value of the Firm Produce what customers want. Meet customer needs efficiently. Greed vs. Self-interest Self-indulgence leads to failure. Customer focus leads to mutual benefit.

Value of the Firm Suppose we plan to bid on an asset that is expect to return profits noted below over the next four years. If we expect to earn at least 10% return on investment, what is the maximum we can pay for this property? t1234 Year Profit$10,000$11,000$12,000$15, NPV =$9,091 $9,016$10,245= $37, The answer

Revenue Relations Total Revenue = Price  Quantity. Marginal Revenue – a change in total revenue associated with a one ‑ unit change in output. Revenue Maximization – Quantity with highest revenue, MR = 0. Do Firms Really Optimize? Inefficiency and waste lead to failure. Optimization techniques are widely employed by successful firms.

Revenue Relations

Maximize Revenue when MR=0 Revenue Relations

Cost Relations Total Cost = Fixed Cost + Variable Cost. Marginal and Average Cost Marginal cost is the change in total cost associated with a one ‑ unit change in output. Average Cost = Total Cost / Quantity Average Cost Minimization Average cost is minimized when MC = AC. Reflects efficient production of a given output level.

Minimize AC when AC = MC Cost Relations Subtracting by -$0.5Q Multiply of 2Q

Cost Relations Minimum AC (AC = MC)

Profit Relations Total and Marginal Profit Total Profit (π ) = Total Revenue - Total Cost. Marginal profit is the change in total profit due to a one-unit change in output, Mπ = MR - MC. Profit Maximization Profit is maximized when Mπ = MR – MC = 0 or MR = MC, assuming profit declines as Q rises. Marginal vs. Incremental Profits Marginal profit is the gain from producing one more unit of output (Q). Incremental profit is gain tied to a managerial decision, possibly involving multiple units of Q.

Maximize Profit when MR = MC Profit Relations

Maximum Profit (MR = MC)