business economics the behavior of firms. assumption: profit maximization problem: you have 6 acres...
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Business Economics
The Behavior of Firms
Assumption: Profit MaximizationProblem: You have 6 acres of land and you are deciding how many acres to spray with insecticide-Variable costs
but no fixed cost
3 15 9
4 18 12
5 20 15
6 21 18
6
6
5
3
4 3
3 3
2 3
1 3
Acres Sprayed
Total Benefit
Total Cost
0 0 0
Net Gain
0
1 6 3 3
Marginal Benefit
Marginal Cost
- -
6 3
2 11 6 5 5 3
Profit Maximization
0
6
11
15
1820
21
0
3
6
9
12
15
18
0
5
10
15
20
25
0 1 2 3 4 5 6
Acres
$
Total Benefits
Total Cost6
6
Profit Maximization
0
1
2
3
4
5
6
7
1 2 3 4 5 6
Acres
$ pe
r A
cre
Marginal Cost
Marginal Benefit
Profit MaximizationTotal Benefit=5+10ln(acre)Marginal Benefit=10/acre
Total Cost=3(acre) Marginal cost=3
Marginal Benefit=Marginal Cost10/acres=3acres=10/3
Net Gain=Total Benefit-Total CostChoose acre to:
Max{Net Gain}=Max{5+10ln(acre)-3(acre)}First Order Condition (10/acre)-3=0
Second Order Condition -10/(acre^2)<0
Maximizing Profits
-50
-40
-30
-20
-10
0
10
20
30
0 1 2 3 4 5 6
Acres
$
Total Benefits
Total Costs
Net Gain
Max
Maximizing Profits
0
1
2
3
4
5
6
7
8
9
10
11
0 2 4 6 8
Acres
$
Marginal Benefits= 10/acres
Marginal Costs=3
Profit MaximizationFix Cost of $4
2 11 10
3 15 13
4 18 16
5 20 19
6 21 22
1
2
2
1
-1
5 3
4 3
3 3
2 3
1 3
Acres Sprayed
Total Benefit
Total Cost
0 0 4
Net Gain
-4
1 6 7 -1
Marginal Benefit
Marginal Cost
- -
6 3
Profit Maximization
0
6
11
15
1820
21
4
7
10
13
16
19
22
0
5
10
15
20
25
0 1 2 3 4 5 6
Acres
$
Profit Maximization
0
1
2
3
4
5
6
7
1 2 3 4 5 6
Acres
$ pe
r (la
st) A
cre
Marginal Cost
Marginal Benefit
Profit MaximizationFix cost of $10
2 11 16
3 15 19
4 18 22
5 20 25
6 21 28
-5
-4
-4
-5
-7
5 3
4 3
3 3
2 3
1 3
Acres Sprayed
Total Benefit
Total Cost
0 0 10
Net Gain
-10
1 6 13 -7
Marginal Benefit
Marginal Cost
- -
6 3
Profit Maximization
0
6
11
15
1820 21
1013
1619
2225
28
0
5
10
15
20
25
30
0 1 2 3 4 5 6
Acres
$
Marginal Rule
If it is worth to produce at all, then it should be produced up to the point where marginal costs are equal to marginal benefits
Revenues
Revenues=
Price X Quantity
Price Quantity Demanded
Total Revenue
0
$10 1 $10
9 2 18
8 3 24
7 4 28
6 5 30
5 6 30
4 7 28
3 8 24
Revenue
D2
Pric
e
Quantity
P
Q
P’
Q’
Should firms maximize revenues?
Profit MaximizationPrice Quantity Total
RevenueMarginal Revenue
0
$10 1 $10 10
9 2 18 8
8 3 24 6
7 4 28 4
6 5 30 2
5 6 30 0
4 7 28 -2
3 8 24 -4
Total Cost
Marginal Cost
Profit
2
3 1 7
5 2 13
8 3 16
12 4 16
17 5 13
23 6 7
30 7 -2
38 8 -14
Change on Fixed Costs
Tot
al C
osts
$
Quantity
Fixed Cost 1
Fixed Cost 2
Total Cost 2
Total Cost 1
Total Revenue
Q*
Total Cost 3
Change on Variable Costs
Tot
al C
osts
$
Quantity
Fixed Cost
Total Cost 2
Total Cost 1Total
Revenue
Q*Q**
Marginal Costs and Revenues
$ pe
r (la
st)
unit
Quantity
Marginal Revenue
Marginal Cost 2
Marginal Cost 1
Q** Q*
Fixed Costs & Sunk Costs
We will call fixed costs to costs that do not change with the level of production and are avoidable by closing the firm (exit the market).
Sunk costs are costs that do not change with the level of production and are not avoidable by closing the firm.