Business Economics The Behavior of Firms

Assumption: Profit Maximization Problem: You have 6 acres of land and you are deciding how many acres to spray with insecticide-Variable costs but no fixed cost Acres Sprayed Total Benefit Total Cost 000 Net Gain Marginal Benefit Marginal Cost

Profit Maximization Total Benefits Total Cost6 6

Profit Maximization Marginal Cost Marginal Benefit

Profit Maximization Total Benefit=5+10ln(acre) Marginal Benefit=10/acre Total Cost=3(acre) Marginal cost=3 Marginal Benefit=Marginal Cost 10/acres=3 acres=10/3 Net Gain=Total Benefit-Total Cost Choose acre to: Max{Net Gain}=Max{5+10ln(acre)-3(acre)} First Order Condition (10/acre)-3=0 Second Order Condition -10/(acre^2)<0

Maximizing Profits Total Benefits Total Costs Net Gain Max

Maximizing Profits Marginal Benefits= 10/acres Marginal Costs=3

Profit Maximization Fix Cost of $ Acres Sprayed Total Benefit Total Cost 004 Net Gain Marginal Benefit Marginal Cost -- 63

Profit Maximization

Marginal Cost Marginal Benefit

Profit Maximization Fix cost of $ Acres Sprayed Total Benefit Total Cost 0010 Net Gain Marginal Benefit Marginal Cost -- 63

Profit Maximization

Marginal Rule If it is worth to produce at all, then it should be produced up to the point where marginal costs are equal to marginal benefits

Revenues Revenues= Price X Quantity PriceQuantity Demanded Total Revenue 0 $

Revenue D2D2 Price Quantity P Q P’ Q’ Should firms maximize revenues?

Profit Maximization PriceQuantityTotal Revenue Marginal Revenue 0 $ Total Cost Marginal Cost Profit

Change on Fixed Costs Total Costs $ Quantity Fixed Cost 1 Fixed Cost 2 Total Cost 2 Total Cost 1 Total Revenue Q* Total Cost 3

Change on Variable Costs Total Costs $ Quantity Fixed Cost Total Cost 2 Total Cost 1 Total Revenue Q*Q**

Marginal Costs and Revenues $ per (last) unit Quantity Marginal Revenue Marginal Cost 2 Marginal Cost 1 Q**Q*

Fixed Costs & Sunk Costs We will call fixed costs to costs that do not change with the level of production and are avoidable by closing the firm (exit the market). Sunk costs are costs that do not change with the level of production and are not avoidable by closing the firm.