ECON 5: Marginal Analysis and a Model of a Business: Production, Cost, Revenue and Profit

profit

Profit = TR - TC 1. business should employ more of the variable resource (labor) if the change in profit from employing another unit of the resource is positive, i.e., if employing more labor raises profit, do it. If employing more labor doesn't raise profit, don't do it. 2. business should produce more output as long as its marginal revenue is greater than its marginal cost. marginal profit of labor: the change in profit divided by the change in the amount of labor employed

modeling profit

Showing profit max: TR>TC by the greatest amount. MR=MC Highest point on the profit function. put the revenue and cost models together and show profit and loss respectively

Modeling cost

TFC, TVC, and TC curves the TC curve has the same shape as the TVC curve, but it's just shifted up by the amount of the TFC. When the slope of the production (Q curve) is getting flatter (lower MP), the slopes of the total cost curves are getting steeper. This is because diminishing marginal productivity (MP) in production gives rise to increasing marginal cost (MC). When the slope of the TC is falling, the MC is falling, and when the slope of the TC is rising, the MC in the lower panel is rising. derive the shapes of the AFC, AVC, and the ATC curves (slope from the origin to a point on the cost line is that cost divided by quantity) For AFC, the slope of this line from the origin gets smaller and smaller as output increases. For AVC and ATC the slope of this line from the origin initially falls as Q increases, but then it starts to increase. Because this slope is average cost, ATC and AVC are u-shaped. short-run cost model of a business: the u-shaped AVC and ATC together, along with MC Note that ATC and AVC get closer together as Q goes up. MC cuts both at the minimum of each.

cost

TFC: total fixed cost (when you have fixed resource/fixed K) ex: rent TVC: L x W (amount of variable resource used x price of resource--like wages) TC: total cost (TFC + TVC) marginal cost (MC): change in TC/change in Q If marginal product is rising, marginal cost is falling. If marginal product is falling, marginal cost is rising. average fixed cost (AFC): starts high and falls as output increases. We can think of the fixed cost being spread over larger and larger levels of output. AFC is never equal to 0, but it approaches 0 as output gets very large. average variable cost (AVC): AVC falls at low levels of output, reaches a minimum, and then rises. average total cost (ATC): the sum of AFC and AVC. Because at low levels of output both AFC and AVC are falling, ATC must fall as well. While AFC continues to fall, AVC eventually starts to rise. Eventually, the rising AVC outweighs the falling AFC, and the sum of the two, ATC, bottoms out and starts to rise as well.

modeling revenue

TR and MR models of a business (Price is identical to MR in this case)

production function (short-run)

a relationship between inputs and outputs similar to the total utility function for the consumer slope of the production function shows diminishing marginal productivity short-run production function, because we have some fixed resources. We see shortly that means we have some fixed cost Q = F(L,K) Output = labor, capital labor on the horizontal axis and output on the vertical axis; capital held constant (changing K makes different function) The slope of the production function with variable labor and fixed capital is called the marginal product of labor

long-run average total cost (LRATC curve)

all resources variable/no fixed costs economies of scale: LRATC falls as output increases, as the scale of the business increases. increasing returns to scale. constant returns to scale: wide range of output with a flat LRATC diseconomies of scale: LRATC increases as output increases. decreasing returns to scale

loss minimization

total cost (TC) curves or with average cost curves The business should shut down in the short-run only if its TR<TVC, or alternatively P<AVC.

revenue

total revenue (TR): Q (quantity/units of output) x P (price) marginal revenue (MR): change in TR/change in Q

rule for maximizing profit

1. business should employ more of the variable resource (labor) if the change in profit from employing another unit of the resource is positive, i.e., if employing more labor raises profit, do it. If employing more labor doesn't raise profit, don't do it. 2. business should produce more output as long as its marginal revenue is greater than its marginal cost. If marginal product is rising, marginal cost is falling. If marginal product is falling, marginal cost is rising.

diminishing marginal productivity

If we keep other resources fixed and increase the employment of just one, the marginal product of that resource, while positive, will begin to decrease, and will continue to decrease as we add more and more of that resource.