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Profit, Total Revenue, Total Cost

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Normal Profit - A level of profit that is just sufficient to maintain ownership. ... lengthening of the managerial chain leads to disorganization. ... – PowerPoint PPT presentation

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Title: Profit, Total Revenue, Total Cost


1
Profit, Total Revenue, Total Cost
  • Profit Total Revenue - Total Cost
  • Accounting Profit Total Revenue - Explicit
    Costs
  • Economic Profit Total Revenue - (explicit and
    implicit cost)
  • Normal Profit - A level of profit that is just
    sufficient to maintain ownership.
  • Total Cost Explicit Implicit Costs
  • Total Cost - explicit payments to the factors of
    production plus the opportunity cost of the
    factors provided by the owner of the firm.
  • Remember, total cost includes the owners wage,
    or a normal rate of return to the owner.

2
The Short-Run
  • Long-run - a firm chooses among all possible
    production techniques
  • Short-run - the firm is constrained in regard to
    what production decisions it can make.
  • Short run - the longest period of time during
    which at least one of the inputs used in a
    production process cannot be varied.
  • Typically a firm can vary labor in the short-run,
    while capital and land are fixed.
  • Hence firms are constrained by the Law of
    Diminishing Returns.

3
The Law of Diminishing Returns
  • Law of Diminishing Returns - As the amount of a
    variable input is increased, holding all else
    constant, the rate of increase in output will
    eventually decline.
  • Law of Diminishing Marginal Productivity - as
    more and more of a variable input is added to an
    existing fixed input, eventually the additional
    output one gets from that individual input is
    going to fall.
  • The Law of Diminishing Returns is the foundation
    on which we build our discussion of short-run
    cost and production.

4
The Stages of Production, Marginal Product, and
Average Product
  • Stages of Production
  • Increasing Returns
  • Decreasing Returns
  • Negative Returns
  • Marginal product - the additional output that
    will be forthcoming from an additional worker,
    other inputs constant.
  • The change in total product that occurs in
    response to a unit change in a variable input
    (ceteris paribus).
  • The amount of output produced by the last unit of
    the input hired.
  • Change in total product / Change in an input
  • Slope of the total product curve
  • Rate of change in total product
  • Average Productivity - output per worker.
  • Total product / Inputs hired
  • Average Product is Maximized AP MP

5
Short Run Total Costs
  • Fixed input - an input whose quantity cannot be
    changed as output changes in the short run.
  • Variable input - an input whose quantity can be
    changed as output changes in the short-run.
  • Total Costs Fixed Costs Variable Costs
  • Fixed costs - costs that are spent and cannot be
    changed in the period of time under
    consideration.
  • costs of production that do not change as output
    change (i.e. land and capital)
  • Variable costs - costs of production that change
    as output changes (i.e. labor and raw materials)

6
Marginal Cost and Average Cost
  • Marginal Cost - the increase in total cost
    associated with a one-unit increase in
    production.
  • Change in total cost / Change in output
  • Slope of the total cost curve
  • Rate of change in total cost
  • Average Total Cost Total cost / quantity that
    is produced
  • Average Total Cost Average Fixed Cost Average
    Variable Cost
  • Minimum Average Total Cost represents the
    cheapest (in terms of per-unit costs) point of
    production.
  • ATC is minimized ATC MC

7
Summarizing Total Cost
  • TC FC VC
  • ATC TC/Q
  • ATC AFC AVC
  • MC change in TC/change in q
  • BE ABLE TO COMPLETE COST TABLE!!!
  • Production, Total Cost and Marginal Cost
  • The Law of Diminishing Returns tells us that as
    labor increases, output will increase eventually
    at a diminishing rate.
  • If additional labor is less productive, than
    total cost will be increasing at an increasing
    rate.
  • Hence, marginal cost, after diminishing returns
    has set in, increases as output increases.
  • We are now able to complete our picture of the
    firm.

8
The Law of Demand
Law of Diminishing Returns
  • Total Cost and Output
  • Marginal Cost and Average Cost
  • AVERAGE COST
  • MINIMIZING LEVEL OF
  • OUTPUT
  • Price and Output
  • via Own-Price Elasticity
  • Total Revenue and Output
  • Marginal Revenue and Output
  • REVENUE MAXIMIZING LEVEL
  • OF OUTPUT

Profit Total Revenue Total Cost Marginal
Profit Marginal Revenue Marginal Cost PROFIT
MAXIMIZING LEVEL OF OUTPUT
9
On the Hiring of Workers
  • Why do firms hire workers? Return to Cost-Benefit
    Analysis
  • Cost The wage the worker is paid. This is
    generally set in the market, not by the firm.
  • Benefit The productivity of the worker
    (marginal product) the value of this
    productivity in the market place (price)
  • Value Marginal Product Marginal Product of
    Labor Price of Output
  • Relevant when the firm has no control over market
    price.
  • Marginal Revenue Product Marginal Product of
    Labor Marginal Revenue of Output
  • Relevant when the firm has some control over
    market price.

10
Profit Maximizing Hiring
  • If W gt MRP What action should the firm take?
  • If W lt MRP What action should the firm take?
  • The firm will maximize profits with respect to
    the hiring of workers when W MRP
  • In what stage of production, then, do firms
    operate? Only in stage two.
  • In stage one, increases in the labor force will
    increase the MRP. If it made sense to hire the
    previous workers, and the next worker offers a
    higher MRP, then it makes sense to hire the next.
    Hence firms will not stop hiring workers in
    Stage One.

11
More History
  • History of marginal productivity theory The work
    of J.B. Clark
  • J.B. Clark (1847-1938) The first American
    economist to contribute to the history of
    economic thought.
  • Ethical implications of Marginal Productivity
    Theory Labor, Capital, and Land are paid
    according to their economic contribution to the
    social product. Therefore analysis contending
    that labor is exploited are naive.
  • Critique of Clarks position
  • Violation of Humes Dictum That what ought to
    be cannot be derived from what is (i.e.
    normative statements cannot be derived from
    positive statements, or in other words, what a
    person should earn is not relative to what the
    person does earn).
  • Conclusion depends upon perfectly competitive
    goods and/or factor markets.
  • How do you measure a workers marginal product?

12
Measuring MRP
  • Joan Robinson (1933) What is actually meant by
    exploitation is usually that the wage is less
    than the marginal revenue product.
  • In most industries the measure of MRP is
    difficult. Sports are the exception.
  • The Gerald Scully approach
  • i. Estimate the value of a win.
  • Revenue f(wins, ...)
  • ii. Estimate the value of the players actions in
    terms of wins.
  • Wins f(player and team statistics)
  • iii. Compare a players estimated MRP to the
    players wage.
  • The Anthony Krautman approach
  • If the market is competitive..... Salary MRP
  • Salary f(player statistics)
  • From this we can learn the value of a players
    statistics and thus analyze the value of non-free
    agents.

13
Profit Maximization vs. Average Cost Minimization
  • The profit maximizing rule gtgtgtgtgt MR MC Why?
  • If MR gt MC profit will rise
  • If MR lt MC profit will decline
  • When MR MC then profit will be maximized.
  • What is the elasticity of demand when profit is
    maximized?
  • Average cost is minimized when ATC MC.
  • What is the significance of the average cost
    minimizing level of output? This is the most
    efficient level of production in the short-run,
    but not necessarily profit maximization.

14
The Long-Run
  • How does a firm decide to expand production?
    Profit maximizing output gt average cost
    minimizing output.
  • Expanding productive facilities moves the firm
    from the short-run to the long-run.
  • Long run - the shortest period of time required
    to alter the amounts of all inputs used in a
    production process.
  • A period of time long enough for all inputs to be
    varied.

15
Economies of Scale
  • Economies of scale - reductions in the minimum
    average cost that come about through increasing
    plant size.
  • specialization of labor.
  • more efficient yet larger equipment.
  • greater volume of output increase efficiency from
    learning.
  • Constant returns to scale - increases in plant
    size do not affect minimum average cost.
  • Diseconomies of scale - increases in plant size
    increase minimum average cost.
  • supervision of workers more difficult (morale
    declines).
  • lengthening of the managerial chain leads to
    disorganization.
  • Long run average total cost is a summary of our
    best short-run cost possibilities.

16
Economic Efficiency
  • Technical efficiency - as few inputs as possible
    are used to produce a given output.
  • Economic efficiency - the method that produces a
    given level of output at the lowest possible
    cost.
  • Economic efficiency is achieved when the amount
    of productivity received from each input per
    dollar spent is equal.
  • Note The production of many goods does not
    follow a fixed recipe. How does the firm choose
    the inputs to use in production?
  • MP1/P1 MP2/P2 ....... MPn/Pn
  • WHY IS THIS IMPORTANT? TO MAXIMIZE PROFITS YOU
    MUST COST MINIMIZE.
  • HOWEVER, COST MINIMIZATION DOES NOT NECESSARILY
    MEAN PROFIT MAXIMIZATION.
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