Microeconomics Chapter 8

There is a connection between the behavior of total revenue and the price of elasticity of demand.

We looked at elasticity as we moved along the market demand curve. THe same concept can be applied to the demand curve facing a single firm.

When would a firm decide to exit and earn zero profit?

When its only other alternative is to earn negative profit.

To maximize profit, the firm should..

produce the quantity of output closest to where MC=MR-- that is, the quantity of output at which the MC and MR curve intersect.

To maximize profit, the firm should...

produce the quantity of output where ethe vertical distance between the TR and TC curve is greatest and the TR curve lies about the TC lines.

An increase in output will always lower profit whenever marginal revenue is less than marginal cost.

(MR<MC)

An increase in output will always raise profit as long as marginal revenue is greater than marginal cost.

(MR>MC)

If the firm by staying open, can earn more than enough revenue to cover its operating costs, then it is making an operating profit.

(TR>TVC), to be sure, the firm is still suffering a loss, but it should not shut down because its operating profit can be used to help pay its fixed costs.

What are some limits for how low cost can go?

1. Production technology 2. the firm must pay prices for each input it uses.

What is profit?

A firm's sales revenue minus its costs of production.

What was the problem with Franklin National Bank?

Accountants figured out the average costs of a dollar in loans, they divided the total cost of funds by the number of dollars they had lent out. The problem was where the funds came from that he was lending out. He went to the federal funds market to obtain the extra money to loan out.

Let Q be the output level at which MR=MC. THen in the short run: If TR= TVC at Q, the firm should _________.

Be indifferent between shutting down and producing.

It sometimes happens that MR is precisely equal to MC. What should the firm do if MR and MC have the same value as output rises?

Both cost and revenue would rise by equal amounts, so increasing output would cause no change in profit.

Whereas marginal values tell the firm what to do, averages can tell the firm how well it is doing.

But average cost should not be in place of marginal cost as a basis for decisions.

What does a firm do when it cannot earn a positive profit at any output level?

Depends on the time horizon. Long run and short run. In the short run, the firm cannot escape paying for its fixed inputs. But the firm can still make decisions about production. One of its options is to shut down.

In the total revenue and total cost approach, we see the firm's profit as the _______ between TC and TR at each output level.

Difference, The firm chooses the output level where profit is the greatest.

Because the firm's demand curve slopes _________, Ned must lower his price to sell more beds.

Downward

Th proper measure of profit for understanding and predicting the behavior of firms is ___________. Unlike accounting profit, economic profit recognizes all the opportunity costs of production-- both explicit and implicit costs.

Economic profit

What is a permanent cessation of production when I firm leaves an industry?

Exit

A firm can also decide to stop producing in the long run. In this case, we say the firm has decided to _____________.

Exit the industry.

Accountants consider only _______ costs in profit.

Explicit

THere is an exception...Sometimes the MC and MR cross at two different points, in this case...

The profit maximizing output level is the one at which the mc curve crosses the MR Curve from below.

In other chapters we talked about the market demand curve, which is all of the demand for the market. In this chapter we talk about the demand curve facing the firm, which tells us...

For different prices, the quantity of output that customers will choose to purchase from that firm.

When the firm lowers its price, it will sell more output.

If demand for the firm's output is elastic (Ed>1), then lowering the price by a given percentage will cause quantity sold to rise by more than that percentage. On the other hand, if demand is inelastic (Ed<1), lowering the price by a given percentage causes quantity sold to rise by a smaller percentage. The firm's total revenue will fall.

What is the shutdown rule?

In the short run, the firm should continue to produce if total revenue exceeds total variable costs; otherwise, it should shut down.

The shutdown rule applies only _____________.

In the short run. In fact we only use the term shut down, in the short run.

Let Q be the output level at which MR=MC. THen in the short run: If TR> TVA at Q the firm should ___________.

Keep producing

What are the two ways to measure the profit maximizing level of output?

Loss and marginal revenue

When an increase in output causes total revenue to fall...

Marginal Revenue is negative, which occurs for all increases in output.

If an increase in output causes total revenue to rise...

Marginal Revenue must be positive.

It makes sense for some unprofitable firms to continue operating.

No matter what output level the firm produces, the TC curve lies above the TR curve, so it will suffer a loss-- a negative profit. FOr this firm, the goal is still profit maximization. But now, the highest profit will be the one with the least negative value. In other words, profit maximization becomes loss minimization.

What does the demand curve facing the firm look like? It depends on...

Perfectly competitive (where the firms take the market price as given) markets or imperfectly competitive markets (where the firm must decide what price to charge).

Entrepreneur's two contributions to profit are _______________ and ______________.

Risk taking and innovation

Let Q be the output level at which MR=MC. THen in the short run: If TR< TVC at Q the firm should _________.

Shut down

If increasing output adds more to revenue than to costs, then increasing output will make any loss ________.

Smaller, this is why in the lower panel , the MC and MR curves must intersect at or very close to Q.

What is the marginal approach to profit?

States that a firm should take any action that adds more to its revenue than to its costs. In this chapter the action being considered is whether to increase output by 1 unit.. Wever learned that a firm should take this action whenever MR>MC.

A common mistake is using average cost in the place of marginal cost when making decisions. What are the problems with this?

The ATC includes costs that are mostly fixed in the short run. Also, the ATC changes as output increases.

The firm has a profit at any output level where TR>TC-- where the TR curve is above the TC curve.

The amount of profit is the vertical distance between the TR and TC curve whenever the TR curve lies above the TC curve.

Where did Franklin go wrong?

The average cost--the figure included an irrelevant cost: the cost of funds obtained from customer deposits. The cost was irrelevant to the customers lending decisions since additional loans would not come from these deposits, but rather from a more expensive federal funds market. Further the marginal cost of an additional dollar of loans was greater than the average cost.MC was greater than MR.

What is marginal revenue?

The change in total revenue from producing one more unit of output. The change in total revenue divided by the change in its output. See pate 229 for equation.

Marginal revenue will always equal what?

The difference between this gain an loss in revenue.

How is loss calculated?

The difference between total cost (TC) and total revenue (TR), when TC>TR.

The MC and MR approach or finding the profit maximizing output level is actually a very specific application of a more general principle:

The marginal approach to profit

With the airline example, where does the 65 percent capacity come from?

The total cost of the airline divided by the number of flights during the year. TC/Q, which is average total cost.

In figure 5 on page, 237,

This firm cannot earn earn an operating profit, since its TR curve lies below its TVC curve everywhere.

What is accounting profit?

Total revenue minus accounting costs.

What is economic profit?

Total revenue minus all costs of production. Total revenue- (explicit costs+ implicit costs)

A firm's ________ is the total inflow of receipts from selling output.

Total revenue= the number of units of output times the price per unit.

Each time output increases, MR is smaller than the price the firm charges at the new output level. For example...

When output increases from 2 to 3 units, the firm's total revenue rises by $450-- even though it sells the third unit for a price of $550. Why? The answer is found in the firm's downward sloping demand curve, which tells us that to sell more output, the firm must cut its price.

If the firm keeps producing (when it is unprofitable) then the smallest possible loss is at output level Q, where the distance between the TC and TR curves is smallest.

Yep

Recall that marginal cost is the change in total cost per unit increase in output.

Yep

When the total revenue curve slopes upward it tells us that...

an increase in output raises total revenue.

Use table 1 on page 227 to...

apply marginal revenue and loss.

A firm should exit the industry in the long run when---

at its best possible output level-- it would suffer a loss.

When a firm faces a downward-sloping demand curve, each increase in output causes a revenue gain from selling additional output at the new price, and a revenue loss, from..

having to lower the price on all pervious units of output. Marginal revenue is therefore less than the price of the last unit of output.

To find the profit-maximizing output level, the firm should...

increase output whenever MR>MC, but not increase output when MR<MC.

Business managers often call TVA the firm's _______ since the firm only pays these variable costs when it continues to operate.

operating cost

However, if the fir cannot even cover its operating costs when it stays open-- that is, if it would suffer an operating loss (TR<TVC)-- it should...

shut down.

In figure 4 on pate 236,

the firm is making an operating profit and should continue to operate.

The demand curve facing the firm show us...

the maximum price the firm can charge to sell any given amount of output.

More output always means greater cost, so...

the numbers in this column are always increasing. For example, at an output of zero, total cost is $300.