University:
California State University, Northridge
Course:
ECON 500 | Survey of Economics
Academic year:

2024
Views:

427

Pages:

27
Author:

Reynaldo Wong

4 The Firm’s Production and Selling Decisions Part 3 Economies of Scale ● Returns to scale indicates how the output level changes when all the firm's inputs are doubled. 1. Increasing Returns to Scale (IRTS): Q output more than doubles. ● IRTS gives a cost advantage to larger firms. Found in industries like telecommunications, electricity, automobiles, and aircraft. 2. Constant Returns to Scale (CRTS): Q output doubles. 3. Decreasing Returns to Scale (DRTS): Q output less than doubles. ● Gives a cost advantage to smaller firms. Most U.S. industries have DRTS. Economies of Scale ● Returns to scale impacts the shape of the AC curve. ● AC = TC/Q output = (P input x Q input)/Q output ♦ E.g., if Q inputs doubles and Q output doubles, then AC is constant. AC Quantity of Output (a) Constant returns to scale AC Quantity of Output (b) Long-Run Average Cost Increasing returns to scale Long-Run Average Cost Long-Run Average Cost FIGURE 9. 3 Possible Shapes for the AC Curve Decreasing returns to scale Quantity of Output (c) AC Economies of Scale ● Law of dim. marginal returns and IRTS may seem contradictory, but they are unrelated. ● Dim. marginal returns refers to increasing a single input. Returns to scale refers to a doubling of all inputs. ● A firm with dim. returns to a single input could have IRTS, CRTS, or DRTS. Price and Quantity: One Decision, Not Two ● Critical decision -when Apple decides how many ipods to produce and P it will charge. ● P affects how consumers respond and Q affects K and L costs. ● When firms chose P and Q to max profits → they can pick only one –P or Q. ♦ Chose P → customers decide Q ♦ Chose Q → market determines P at which this Q can be sold FIGURE 10. Demand Curve for Flo’s Poultry Meat Price per package Flo faces a local D curve. A $19 If she picks P = $19 → Qd = 1. If she picks Q = 9 → P = $11 to find required # of customers. B $11 D 1 9 Quantity of Chicken (20 lb-packages per week) Price and Quantity: One Decision, Not Two ● Each pt on D curve corresponds to a (P,Q) pair. A firm can pick 1 pair, but it can never pick P from 1 pt on D and a different Q from another pt on D. ● Economists assume that firms pick (P,Q) pair that maximizes profits. Total Profit: Keep Your Eye on the Goal ● Total profit (or economic profit) = TR – TC (including opportunity cost) ♦ Opportunity costs include any K or L supplied by the firm’s owners. ● Economic profit = Accounting profit – opportunity cost. ♦ E.g., if a talented attorney, gives up her salary of $120,000 to start her own law firm and earns $150,000 after paying for all operating costs → accounting profit = $150,000 but economic profit = $30,000 ♦ E.g., if you start a business and earn 6% on money you invested but could have earned 4% in T-Bills → economic profit = 2%. Total Profit: Keep Your Eye on the Goal ● Total, Average, and Marginal Revenue: ♦ Total Revenue (TR) = P × Q ■ Calculated from D curve ♦ Average Revenue (AR) = TR/Q = (P × Q)/Q = P ■ AR curve = D curve ♦ Marginal Revenue (MR) = ∆ TR when ↑output by 1 unit. ■ Slope of TR curve TABLE 5. Schedule of Flo’s Total, Average, and Marginal Revenue Chicken (20 lb-pack) Price (or AR) ($ per package) Total Revenue (P x Q) Marginal Revenue 0 ----- 0 ----- 1 $19 $19 $19 2 18 36 17 3 17 51 15 4 16 64 13 5 15 75 11 6 14 84 9 7 13 91 7 8 12 96 5 9 11 99 3 10 10 100 1 FIGURE 11. Flo’s Total Revenue Curve Total Revenue Total Revenue $100 $80 $60 $40 $20 $0 0 2 4 6 8 Quantity of Chicken (20-lb packages) 10 Total Profit: Keep Your Eye on the Goal ● Total, Average, and Marginal Cost: ♦ TC = P inputs x Q inputs ♦ AC = TC/Q output ■Per unit costs ♦ MC = ∆TC when ↑output by 1 unit. ■Slope of TC curve TABLE 6. Flo’s Total, Average, and Marginal Cost Chicken (20 lb-pack) Total Cost Marginal Cost Average Cost 0 $0.0 ----- ----- 1 17.0 $17.0 $17.0 2 26.0 9.0 13.0 3 33.0 7.0 11.0 4 40.0 7.0 10.0 5 48.0 8.0 9.6 6 57.0 9.0 9.5 7 67.2 10.2 9.6 8 80.0 12.8 10.0 9 99.0 19.0 11.0 10 125.0 26.0 12.5 FIGURE 12(a). Flo’s Total Cost Curve Total Cost $120.00 Total Cost $100.00 $80.00 $60.00 $40.00 $20.00 $0.00 0 2 4 6 8 Quantity of Chicken (20-lb packages per week) 10 FIGURE 12(b). Flo’s Average and Marginal Cost Curves Average and marginal cost Average and Marginal Cost 30 25 20 MC AC 15 10 5 0 1 2 3 4 5 6 7 8 9 10 Quantity of Chicken (20-lb packages per week) 11 Total Profit: Keep Your Eye on the Goal ● Maximization of Total Profits: ♦ Profits typically increase with output, then fall. ♦ Some intermediate level of output generates max profit. TABLE 7. TR, TC, and Profit for Flo Chicken (20 lb-pack) Total Revenue (P x Q) Total Cost Total Profit 0 $0 $0.0 $0.0 1 19 17.0 2.0 2 36 26.0 10.0 3 51 33.0 18.0 4 64 40.0 24.0 5 75 48.0 27.0 6 84 57.0 27.0 7 91 67.2 23.8 8 96 80.0 16.0 9 99 99.0 0.0 10 100 125.0 -25.0 Total Profit: Keep Your Eye on the Goal ● In our example: ♦ Total profit (Π) is max at 5 or 6 packages, where farm earns its highest profits of $27 per week. ♦ Any other Q level → ↓Π ■E.g., if Q = 3 → Π = $18 or if Q = 8 → Π = $16 Marginal Analysis and Maximization of Total Profit ● Use marginal analysis to find Q that max profits. ● Marginal profit = ∆ total profit when ↑Q by 1 unit. ♦ Slope of total profit curve ● Rule: if marginal Π > 0 → ↑Q if marginal Π < 0 → ↓Q ♦ Profit-max Q is reached when marginal Π = 0. ● Graphically, only reach top of total profit “hill” when marginal profit (its slope) = 0. FIGURE 13(a). Profit Maximization Total Profit per week ($) Total Profit “hill” 27 20 0 –20 –30 1 2 3 4 5 6 7 8 9 10 Output, Packages per week Total profit has a “hill” shape. At Q = 0, Π = 0. At larger Q levels, firm floods the market, and ↓Π. Only at intermediate Q levels is Π > 0. Marginal Analysis and Maximization of Total Profit ● Like marginal Π, MR and MC can guide us to Q output where total profit is maximized. ● MR = slope of TR and MC = slope of TC ● Total profit is max when TR and TC are farthest apart. ♦ Occurs when their slopes are equal, so they are not growing closer together (Π↓) or growing further apart (Π↑). ● Rule: if MR > MC → ↑Q if MR < MC → ↓Q ♦ Profit maximizing Q is where MR = MC. FIGURE 13(b). Profit Maximization Total Revenue, Total Cost per week ($) Total Π = vertical distance between TR and TC curves TC 125 99 84 TR 57 Profit 20 $27 0 1 2 3 4 5 6 7 Output, packages per week 8 9 10 TABLE 8. Maximization of Flo’s Total Profits Output (packages) Marginal Revenue Marginal Cost Marginal Profit Total Profit 0 ----- ----- ----- $0.0 1 $19 $17.0 $2.0 2.0 2 17 9.0 8.0 10.0 3 15 7.0 8.0 18.0 4 13 7.0 6.0 24.0 5 11 8.0 3.0 27.0 6 9 9.0 0.0 27.0 7 7 10.2 -3.2 23.8 8 5 12.8 -7.8 16.0 9 3 19.0 -16.0 0.0 10 1 26.0 -25.0 -25.0 Marginal Analysis and Maximization of Total Profit ● Finding the Optimal P from Optimal Q: ● Optimal Q is where MR = MC (and marg. Π = 0). ♦ E.g., at Q = 6; MR = MC = $9. ● Producer picks Q then demand curve ⇒ P buyers will pay to purchase that level of output. ♦ E.g., at Q = 6 → P = $14 –only P at which this Q is purchased by consumers. Logic of Marginal Analysis & Maximization ● Decision makers constantly faced with problem of choosing the magnitude of some variable. ♦ E.g., how many cars to produce; how many workers to hire, or how many pints of ice cream to buy. ● Generally, larger the number selected → higher the total benefit. However, costs ↑ as number chosen ↑. ● Optimally, decision makers chose Q of some variable where difference between total benefit and total cost is greatest. Logic of Marginal Analysis & Maximization ● Decide about Q of some variable, then max net benefit = total benefit – total cost by choosing the Q where marginal benefit = marginal cost. ● Rule is true regardless of who the decision maker is. Decision maker Marginal benefit Marginal cost Choice variable Objective consumer MU P good Q of good Max CS firm MRP input P input Q of 1 input Max Π firm MR output MC output Q of output Max Π

The Firm’s Production and Selling Decisions, Part 3

Related Documents

Recommended Documents

Description

Related Documents

Free up your schedule!

Take 5 seconds to unlock