1. To define & evaluate a range of key cost, revenue & production related concepts

2. To explain the inter- relationship between costs (focusing upon the short –run)

3. To understand the concept of revenue, and the importance of profit maximisation

Theory of Production & Costs

Lecture Objectives:

Costs ofproduction Revenues

Firms’ rational decisions about how much output to supply depend upon…..

Firm chooseslevel ofoutput

Accounting cost actual payments for resources in a period

Opportunity cost amount lost by not using a resource in its best

alternative use Economists include opportunity cost in a

firm’s total costs

Average cost: Total Cost output

Marginal cost =

TCQx

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TVC

TFC

Output(Q)

01234567

TFC(£)

1212121212121212

TVC(£)

010162128406091

0

20

40

60

80

100

0 1 2 3 4 5 6 7 8

TC

TVC

TFC

Output(Q)

01234567

TFC(£)

1212121212121212

TVC(£)

010162128406091

TC(£)

12222833405272

103

Total Revenue: (P x Q)

Average revenue: Total Revenue output

Marginal revenue = TR

Q

7.8

Sales (Q) Average revenue (AR)

Total revenue (TR)

Marginal revenue (MR)

1 300 300 3002 280 560 2603 260 780 2204 240 960 1805 220 1100 1406 200 1200 1007 180 1260 608 160 1280 209 140 1260 -2010 120 1200 -60

7.9

Q TFC TVC AFC AVC TC AC MC0 500 0 - - 500 - -1 500 100 500 100 600 600 1002 500 180 250 90 680 340 803 500 250 167 83 750 250 704 500 310 125 78 810 202 605 500 380 100 76 880 176 706 500 470 83 78 970 162 907 500 580 71 83 1080 154 1108 500 730 63 91 1230 154 1509 500 930 56 103 1430 159 200

7.10

7.11

7.12

OutputQ1

E

MC

, MR

MC

MR

0

If MR > MC, an increasein output will increaseprofits.If MR < MC, a decreasein output will increaseprofits.So profits are maximized when MR = MC at Q1

(so long as the firmcovers average variable costs)