Chapter 8 Impacts of Output Decisions on Short

Chapter 8: Impacts of Output Decisions on Short. Run Costs, Revenues, and Profits for Competitive Firms

Key Topics 1. Cost concepts a. b. c. d. e. 2. Revenue concepts a. b. 3. Cash and Non Cash Variable and Fixed Total: TFC, TVC, TC Average: AFC, AVC, ATC, AVC & AP Marginal: MC, MC & MP Total Marginal Profit concepts a. b. Profit maximizing output Firm & market supply

Profit Overview (recall) l Profit = TR – TC l TR depends on P of output, Q of output l TC depends on P of inputs, Q of inputs, productivity of inputs, production technology used

Recent Examples of Firm ‘Cost’ Concerns GM 1. Spent $5 billion to costs of producing Saturn cars Labor costs per car for GM were 2 x Toyota’s - United, Delta, & other airlines 2. - Southwest’s costs often 50% less Sears, K-Mart, Target 3. - Trying to compete with Walmart on basis of costs Georgia Pacific 4. - Started using ‘thinner’ saws Less saw dust 800 more rail cars of lumber per year

Cost Concepts (see Table 8. 5) l Cash and Non Cash l Fixed and Variable l Total, Average, and Marginal

Opportunity Cost Examples Activity Opportunity Cost Operate own business Lost wages and interest Own and farm land Lost rent and interest Buy and operate equipment Lost interest and rent

Total Fixed vs. Total Variable Costs TFC TVC TC = = = = = total fixed costs that have to be paid even if output = 0 costs that do NOT vary with changes in output ‘overhead’ and ‘sunk’ costs total variable costs that DO vary with changes in output 0 if output = 0 total costs TFC + TVC

Average Costs AFC = = AVC = = ATC = = fixed costs per unit of output TFC/q variable costs per unit of output TVC/q total costs per unit of output TC/q = AFC + AVC

Marginal Cost MC = additional cost per unit of additional output = = slope of TC and slope of TVC curves

Cost Tables l See 8. 1, 8. 2, 8. 3, 8. 4

Cost Curve Graphs TFC, AFC TVC, AVC TC, ATC MC (see Figs. 8. 2 thru 8. 8)

Product and Cost Relationships Assume variable input = labor MP = ΔQ/ΔL TVC = W ∙ L MC = note: MC Δ is opposite of MP Δ AVC = note: AVC Δ is opposite of AP Δ

MC, AVC, and ATC Relationships If MC > AVC is increasing If MC < AVC is declining If MC > ATC is increasing If MC < ATC is declining

Total Revenue (TR) and Marginal Revenue (MR) l Total revenue (TR) is the total amount that a firm takes in from the sale of its output. TR = P x q l l Marginal revenue (MR) is the additional revenue that a firm takes in when it increases output by one additional unit. In perfect competition, P = MR.

Comparing Costs and Revenues to Maximize Profit l l l The profit-maximizing level of output for all firms is the output level where MR = MC. In perfect competition, MR = P, therefore, the firm will produce up to the point where the price of its output is just equal to short-run marginal cost. The key idea here is that firms will produce as long as marginal revenue exceeds marginal cost.

Profit Max l Table (8. 6) l MR = MC graph (Fig. 8. 10) l TR, TC graph?

Q. True or False? Fixed costs do not affect the profitmaximizing level of output? A. True. Only, marginal costs (changes in variable costs) determine profit-maximizing level of output. Recall, profit-max output rule is to produce where MR = MC.

Firm & Market Supply Firm S = Market S = See Fig. 8. 11 MC curve above AVC sum of individual firm supplies

Q. Should a firm ‘shut down’ in SR? A. Profit if ‘produce’ = TR – TVC – TFC Profit if ‘don’t produce’ or ‘shut down’ = -TFC Shut down if TR – TVC – TFC < -TFC TR – TVC < 0 TR < TVC