Production & Profits

Production & ProfitsProduction and ProfitsJennifer and Jason run an organic tomato farmThe market price of organic tomatoes is $18 per bushel Jennifer and Jason are price takers they can sell as much as they like at that priceWhat is there profit-maximizing level of output by direct calculation?Production and ProfitTotal Revenue = P x QProfit = TR TCProfit is maximized at an output of 5 bushels, where profit is equal to $18

Marginal Analysis & Profit-Maximizing Quantity of OutputMarginal Analysis is when the optimal amount of an activity is the level at which marginal benefit is equal to marginal costTo apply to profit-maximization: considering the effect on a producers profit of increasing output by one unitMarginal revenue is the change in total revenue generated by an additional unit of output

Marginal Analysis & Profit-Maximizing Quantity of OutputMarginal revenue formula:

MR = TR/Q

Marginal Analysis & Profit-Maximizing Quantity of OutputJennifer and Jason can maximize their profit by producing bushels up to the point at which the marginal revenue is equal to marginal costProducers optimal output rule: profit is maximized by producing the quantity at which the MR of the last unit produced is equal to its marginal costMR = MC at the optimal quantity of outputMarginal Analysis & Profit-Maximizing Quantity of Output

Marginal Analysis & Profit-Maximizing Quantity of OutputThe net gain being negative in the 6th and 7th bushels illustrates another rule:Price-taking firms optimal output rule a price taking firms profit is maximized by producing the quantity of out put at which the market price is equal to the marginal cost of the last unit producedP = MC at the price-taking firms optimal quantity of outputMarginal Analysis & Profit-Maximizing Quantity of OutputReally, the price-taking firms optimal output rule is just an application of the optimal output rule to the case of a price-taking firmWHY?In the case of a price-taking firm, marginal revenue is equal to the market price

The Price-Taking Firms Profit-Maximizing Quantity of Output76543210$242018161286Price, cost of bushelQuantity of tomatoes (bushels)MCMR= PEProfit-maximizing quantityOptimal pointMarket priceThe marginal revenue curve shows how marginal revenue varies as output variesFigure Caption: Figure 13-1: The Price-Taking Firms Profit-Maximizing Quantity of OutputAt the profit-maximizing quantity of output, the market price is equal to marginal cost. It is located at the point where the marginal cost curve crosses the marginal revenue curve, which is a horizontal line at the market price. Here, the profit-maximizing point is at an output of 5 bushels of tomatoes, the output quantity at point E.Marginal Analysis & Profit-Maximizing Quantity of OutputAre all price-taking firms production decision summed up as produce up to the point where marginal cost of production is equal to the price?NO!Before you apply Marginal Analysis to determine how much to produce, a producer must answer an either-or questionshould it produce at all?When is Production Profitable?Economic profit is the measure based on the opportunity cost of resources used in the businessTo calculate economic profit, a firms total cost incorporates the implicit cost (benefits forgone in the next best use of the firms resources) as well as explicit cost incurred by the firm

When is Production Profitable?What determines if Jennifer and Jasons farm earns a profit or generates a loss?Whether the market price of organic tomatoes is more or less than the farms minimum average total costCalculation of short-run AVC and short-run ATC**short-run due to all variables are fixed costs**

Costs and Production in the Short Run 76543210$301814MCATCMR= PCBreak even priceMinimum-cost outputPrice, cost of bushelQuantity of tomatoes (bushels)Minimum average total costFigure Caption: Figure 13-2: Costs and Production in the Short RunThis figure shows the marginal cost curve, MC, and the short-run average total cost curve, ATC. When the market price is $14, output will be 4 bushels of tomatoes (the minimum-cost output), represented by point C. The price of $14, equal to the firms minimum average total cost, is the firms breakeven price.When is Production Profitable?Profit is equal to total revenue minus total cost, TR-TC:

If TR > TC, the firm is profitable.

If TR = TC, the firm breaks even.

If TR < TC, the firm incurs a loss.When is Production Profitable?Also can express this in terms of revenue and cost per unit of outputDivide profit by number of units of output, Q:Profit/Q = TR/Q TC/QTR/Q is average revenue (market price)TC/Q is average total cost

Profitability and the Market Price 76543210MCProfitATCMR= PCZEMarket Price = $181414.40$18Price, cost of bushelQuantity of tomatoes (bushels)Minimum average total costBreak even priceArea of the shaded rectangle shows Jennifer and Jasons total profit when market price is $18. Can be expressed:Profit = TR TC = (TR/Q TC/Q) x QOrProfit = (P ATC) x QFigure Caption: Figure 13-3: Profitability and the Market PriceIn panel (a) the market price is $18. The farm is profitable because price exceeds minimum average total cost, the breakeven price, $14. The farms optimal output choice is indicated by point E, corresponding to an output of 5 bushels. The average total cost of producing 5 bushels is indicated by point Z on the ATC curve, corresponding to an amount of $14.40. The vertical distance between E and Z corresponds to the farms per unit profit, $18.00 $14.40 =$3.60. Total profit is given by the area of the shaded rectangle, 5 $3.60 =$18.00. Profitability and the Market Price 76543210MCLossATCMR= PCAYMarket Price = $101410$14.67Price, cost of bushelQuantity of tomatoes (bushels)Minimum average total costBreak even priceFigure Caption: Figure 13-3: Profitability and the Market PriceIn panel (b) the market price is $10; the farm is unprofitable because the price falls below the minimum average total cost, $14. The farms optimal output choice when producing is indicated by point A, corresponding to an output of three bushels. The farms per-unit loss, $14.67 $10.00 =$4.67, is represented by the vertical distance between A and Y. The farms total loss is represented by the shaded rectangle, 3 $4.67 = $14.00 (adjusted for rounding error).Profitability and the Market Price How does a producer know, in general, whether or not its business will be profitable?

Need to compare the market price to the producers minimum average total cost

Profitability and the Market Price 76543210MCLossATCMR= PCAYMarket Price = $101410$14.67Price, cost of bushelQuantity of tomatoes (bushels)Minimum average total costBreak even priceFor Jennifer and Jason, minimum average total cost ($14) occurs at an output quantity of 4 bushels.Whenever market price exceeds minimum average total cost, the producer can find some output level for which the average total cost is less than the market price.If the market price is less than minimum average total cost, there is not output level at which price exceeds average total cost. Due to this, the firm will be unprofitable at any quantity of output.Figure Caption: Figure 13-3: Profitability and the Market PriceIn panel (b) the market price is $10; the farm is unprofitable because the price falls below the minimum average total cost, $14. The farms optimal output choice when producing is indicated by point A, corresponding to an output of three bushels. The farms per-unit loss, $14.67 $10.00 =$4.67, is represented by the vertical distance between A and Y. The farms total loss is represented by the shaded rectangle, 3 $4.67 = $14.00 (adjusted for rounding error).Profitability and the Market Price Minimum average total cost of a price-taking firm is its break-even priceThe price at which it earns zero profit (called economic profit)At firm will earn positive profit when the market price is above the break-even price and it will suffer losses when the market price is below the break-even priceProfitability and the Market Price Rules determining whether a producer of a good is profitable depends on a comparison of the market price of the good to the producers break-even price:

Whenever market price exceeds minimum average total cost, the producer is profitable.

Whenever the market price equals minimum average total cost, the producer breaks even.

Whenever market price is less than minimum average total cost, the producer is unprofitable.

Production & Profits NotesProduction and ProfitTotal Revenue =Profit =Profit is maximized at an output of 5 bushels, where profit is equal to $18

Marginal Analysis & Profit-Maximizing Quantity of OutputMarginal Analysis is

To apply to profit-maximization: considering the effect on a producers profit of increasing output by one unitMarginal revenue is the change in total revenue generated by an additional unit of output

Marginal Analysis & Profit-Maximizing Quantity of OutputMarginal revenue formula:

Marginal Analysis & Profit-Maximizing Quantity of OutputJennifer and Jason can maximize their profit by producing bushels up to the point at which the marginal revenue is equal to marginal costProducers optimal output rule: Marginal Analysis & Profit-Maximizing Quantity of Output

Marginal Analysis & Profit-Maximizing Quantity of OutputThe net gain being negative in the 6th and 7th bushels illustrates another rule:Price-taking firms optimal output rule

P = MC at the price-taking firms optimal quantity of outputMarginal Analysis & Profit-Maximizing Quantity of OutputReally, the price-taking firms optimal output rule is just an application of the optimal output rule to the case of a price-taking firmWHY?In the case of a price-taking firm, marginal revenue is equal to the market price

The Price-Taking Firms Profit-Maximizing Quantity of Output76543210$242018161286Price, cost of bushelQuantity of tomatoes (bushels)MCMR= PEProfit-maximizing quantityOptimal pointMarket priceFigure Caption: Figure 13-1: The Price-Taking Firms Profit-Maximizing Quantity of OutputAt the profit-maximizing quantity of output, the market price is equal to marginal cost. It is located at the point where the marginal cost curve crosses the marginal revenue curve, which is a horizontal line at the market price. Here, the profit-maximizing point is at an output of 5 bushels of tomatoes, the output quantity at point E.Marginal Analysis & Profit-Maximizing Quantity of OutputAre all price-taking firms production decision summed up as produce up to the point where marginal cost of production is equal to the price?NO!Before you apply Marginal Analysis to determine how much to produce, a producer must answer an either-or questionshould it produce at all?When is Production Profitable?Economic profit is the measure based on the opportunity cost of resources used in the businessTo calculate economic profit, When is Production Profitable?What determines if Jennifer and Jasons farm earns a profit or generates a loss?Whether the market price of organic tomatoes is more or less than the farms minimum average total costCalculation of short-run AVC and short-run ATC**short-run due to all variables are fixed costs**

Costs and Production in the Short Run 76543210$301814MCATCMR= PCBreak even priceMinimum-cost outputPrice, cost of bushelQuantity of tomatoes (bushels)Minimum average total costFigure Caption: Figure 13-2: Costs and Production in the Short RunThis figure shows the marginal cost curve, MC, and the short-run average total cost curve, ATC. When the market price is $14, output will be 4 bushels of tomatoes (the minimum-cost output), represented by point C. The price of $14, equal to the firms minimum average total cost, is the firms breakeven price.When is Production Profitable?Profit is equal to total revenue minus total cost, TR-TC:

If TR > TC,

If TR = TC,

If TR < TC, When is Production Profitable?Also can express this in terms of revenue and cost per unit of outputDivide profit by number of units of output, Q:

TR/Q is average revenue (market price)TC/Q is average total cost

Profitability and the Market Price 76543210MCATCMR= PCZEMarket Price = $181414.40$18Price, cost of bushelQuantity of tomatoes (bushels)Minimum average total costBreak even priceFigure Caption: Figure 13-3: Profitability and the Market PriceIn panel (a) the market price is $18. The farm is profitable because price exceeds minimum average total cost, the breakeven price, $14. The farms optimal output choice is indicated by point E, corresponding to an output of 5 bushels. The average total cost of producing 5 bushels is indicated by point Z on the ATC curve, corresponding to an amount of $14.40. The vertical distance between E and Z corresponds to the farms per unit profit, $18.00 $14.40 =$3.60. Total profit is given by the area of the shaded rectangle, 5 $3.60 =$18.00. Profitability and the Market Price 76543210MCATCMR= PCAYMarket Price = $101410$14.67Price, cost of bushelQuantity of tomatoes (bushels)Minimum average total costBreak even priceFigure Caption: Figure 13-3: Profitability and the Market PriceIn panel (b) the market price is $10; the farm is unprofitable because the price falls below the minimum average total cost, $14. The farms optimal output choice when producing is indicated by point A, corresponding to an output of three bushels. The farms per-unit loss, $14.67 $10.00 =$4.67, is represented by the vertical distance between A and Y. The farms total loss is represented by the shaded rectangle, 3 $4.67 = $14.00 (adjusted for rounding error).Profitability and the Market Price How does a producer know, in general, whether or not its business will be profitable?

Need to compare the market price to the producers minimum average total cost

Profitability and the Market Price 76543210MCATCMR= PCAYMarket Price = $101410$14.67Price, cost of bushelQuantity of tomatoes (bushels)Figure Caption: Figure 13-3: Profitability and the Market PriceIn panel (b) the market price is $10; the farm is unprofitable because the price falls below the minimum average total cost, $14. The farms optimal output choice when producing is indicated by point A, corresponding to an output of three bushels. The farms per-unit loss, $14.67 $10.00 =$4.67, is represented by the vertical distance between A and Y. The farms total loss is represented by the shaded rectangle, 3 $4.67 = $14.00 (adjusted for rounding error).Profitability and the Market Price Minimum average total cost of a price-taking firm is its break-even priceThe price at which it earns zero profit

At firm will earn positive profit when the market price is above the break-even price and it will suffer losses when the market price is below the break-even priceProfitability and the Market Price Rules determining whether a producer of a good is profitable depends on a comparison of the market price of the good to the producers break-even price:

Whenever market price exceeds minimum average total cost,

Whenever the market price equals minimum average total cost,

Whenever market price is less than minimum average total cost,