Background To Supply
This document was uploaded by user and they confirmed that they have the permission to share it. If you are author or own the copyright of this book, please report to us by using this DMCA report form. Report DMCA
Overview
Download & View Background To Supply as PDF for free.
More details
- Words: 4,535
- Pages: 143
Background to Supply
Background to Supply
The Short-run Theory of Production
SHORT-RUN THEORY OF PRODUCTION • Profits and the aims of the firm • Long-run and short-run production: – fixed and variable factors
• The law of diminishing returns • The short-run production function: – total physical product (TPP) – average physical product (APP) APP = TPP/QV – marginal physical product (MPP) MPP = ∆TPP/∆QV
Wheat production per year from a particular farm (tonnes)
Wheat production per year from a particular farm (tonnes)
Wheat production per year from a particular farm (tonnes)
Wheat production per year from a particular farm (tonnes)
SHORT-RUN THEORY OF PRODUCTION • Profits and the aims of the firm • Long-run and short-run production: – fixed and variable factors
• The law of diminishing returns • The short-run production function: – total physical product (TPP) – average physical product (APP) APP = TPP/QV – marginal physical product (MPP) MPP = ∆TPP/∆QV – graphical relationship between TPP, APP and MPP
Wheat production per year from a particular farm Number of workers 0 1 2 3 4 5 6 7 8
Tonnes of wheat produced per year
40
30
20
TPP 0 3 10 24 36 40 42 42 40
10
0 0
1
2
3
4
5
Number of farm workers
6
7
8
Wheat production per year from a particular farm Number of workers 0 1 2 3 4 5 6 7 8
Tonnes of wheat produced per year
40
30
20
TPP 0 3 10 24 36 40 42 42 40
10
0 0
1
2
3
4
5
Number of farm workers
6
7
8
Wheat production per year from a particular farm d Tonnes of wheat produced per year
40
TPP Maximum output
30
Diminishing returns set in here
20
b
10
0 0
1
2
3
4
5
Number of farm workers
6
7
8
Tonnes of wheat per year
Wheat production per year from a particular farm 40
TPP 30
20
10
∆TPP = 7 0
Tonnes of wheat per year
6
7
8
Number of farm workers (L)
6
7
8
Number of farm workers (L)
0 1
2
3
4
5
∆L = 1
14 12 10 8
MPP = ∆TPP / ∆L = 7
6 4 2 0 -2
0
1
2
3
4
5
Tonnes of wheat per year
Tonnes of wheat per year
Wheat production per year from a particular farm 40
TPP 30
20
10
0
1
2
3
4
5
6
7
8
Number of farm workers (L)
0
1
2
3
4
5
6
7
8
Number of farm workers (L)
0
14 12 10 8 6 4 2 0 -2
MPP
Tonnes of wheat per year
Wheat production per year from a particular farm 40
TPP 30
20
10
0
Tonnes of wheat per year
0
1
2
3
4
5
6
7
8
Number of farm workers (L)
14
APP = TPP / L
12 10 8 6
APP
4 2 0 -2
0
1
2
3
4
5
6
7
8
MPP
Number of farm workers (L)
Tonnes of wheat per year
Wheat production per year from a particular farm 40
TPP 30
b
20
10
0 0
Tonnes of wheat per year
Diminishing returns set in here
1
2
3
4
5
6
7
8
Number of farm workers (L)
b
14 12 10 8 6
APP
4 2 0 -2
0
1
2
3
4
5
6
7
8
MPP
Number of farm workers (L)
Wheat production per year from a particular farm Tonnes of wheat per year
d
40
TPP 30
20
10
0 0
Tonnes of wheat per year
Maximum output
b
1
2
3
4
5
6
7
8
Number of farm workers (L)
b
14 12 10 8 6
APP
4 2
d
0 -2
0
1
2
3
4
5
6
7
8
MPP
Number of farm workers (L)
Wheat production per year from a particular farm Tonnes of wheat per year
d
Slope = TPP / L = APP
40
TPP
30
20
b
10
0 0
Tonnes of wheat per year
c
1
2
3
4
5
6
7
8
Number of farm workers (L)
b
14 12 10
c
8 6 4
APP
2
d
0 -2
0
1
2
3
4
5
6
7
8
MPP
Number of farm workers (L)
Background to Supply
Short-run Costs
SHORT-RUN COSTS • Measuring costs of production: opportunity costs – explicit costs – implicit costs
• Fixed costs and variable costs • Total costs – total fixed cost (TFC) – total variable cost (TVC) – total cost (TC = TFC + TVC)
Total costs for firm X
Output TFC (Q) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
40
20
0 0
1
2
3
4
5
6
7
8
Total costs for firm X
Output TFC (Q) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Total costs for firm X
Output TFC TVC (Q) (£) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
0 10 16 21 28 40 60 91
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Total costs for firm X
Output TFC TVC (Q) (£) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
0 10 16 21 28 40 60 91
TVC
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Output TFC TVC (Q) (£) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
TC (£)
0 10 16 21 28 40 60 91
Total costs for firm X
12 22 28 33 40 52 72 103
TVC
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Output TFC TVC (Q) (£) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
TC (£)
0 10 16 21 28 40 60 91
Total costs for firm X TC
12 22 28 33 40 52 72 103
TVC
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Total costs for firm X TC
100
TVC 80
Diminishing marginal returns set in here
60
40
20
TFC 0 0
1
2
3
4
5
6
7
8
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns
Average and marginal physical product
Output
b
Diminishing returns set in here
MPP
Quantity of the variable factor
Average and marginal physical product b
Output
c
APP
MPP
Quantity of the variable factor
Marginal cost
Costs (£)
MC
Diminishing marginal returns set in here
x
Output (Q)
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
Total costs for firm X TC
100
TVC 80
Bottom of the MC curve
60
40
20
TFC 0 0
1
2
3
4
5
6
7
8
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost – average fixed cost (AFC)
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost – average fixed cost (AFC) – average variable cost (AVC)
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost – average fixed cost (AFC) – average variable cost (AVC) – average (total) cost (AC)
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost – average fixed cost (AFC) – average variable cost (AVC) – average (total) cost (AC) – relationship between AC and MC
Average and marginal costs MC
AC
Costs (£)
AVC
z y x AFC
Output (Q)
Background to Supply
The Long-run Theory of Production
LONG-RUN THEORY OF PRODUCTION • All factors variable in long run • The scale of production: – constant returns to scale – increasing returns to scale – decreasing returns to scale
Short-run and long-run increases in output
LONG-RUN THEORY OF PRODUCTION • Economies of scale – specialisation & division of labour – indivisibilities – container principle – greater efficiency of large machines – by-products – multi-stage production – organisational & administrative economies – financial economies – economies of scope
LONG-RUN THEORY OF PRODUCTION • Diseconomies of scale • External economies and diseconomies of scale • Optimum combination of factors MPPa/Pa = MPPb/Pb ... = MPPn/Pn
Background to Supply
Isoquant–Isocost Analysis
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape
An isoquant 45 40
Units of K 40 20 10 6 4
Units of capital (K)
35 30 25
Units of L 5 12 20 30 50
Point on diagram a b c d e
20 15 10 5 0 0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
An isoquant 45
a
40
Units of K 40 20 10 6 4
Units of capital (K)
35 30 25
Units of L 5 12 20 30 50
Point on diagram a b c d e
20 15 10 5 0 0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
An isoquant 45
a
40
Units of K 40 20 10 6 4
Units of capital (K)
35 30 25
Units of L 5 12 20 30 50
Point on diagram a b c d e
b
20 15 10 5 0 0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
An isoquant 45
a
40
Units of K 40 20 10 6 4
Units of capital (K)
35 30 25
Units of L 5 12 20 30 50
Point on diagram a b c d e
b
20 15
c
10
d
e
5 0 0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution
Diminishing marginal rate of factor substitution 14
g
Units of capital (K)
12 ∆K = 2
MRS = ∆K / ∆L
MRS = 2 h
10 ∆L = 1
8 6 4 2
isoquant
0 0
2
4
6
8
10
12
14
Units of labour (L)
16
18
20
22
Diminishing marginal rate of factor substitution 14
g
Units of capital (K)
12 ∆K = 2
MRS = ∆K / ∆L
MRS = 2 h
10 ∆L = 1
8
j
MRS = 1 k
∆K = 1
6
∆L = 1
4 2
isoquant
0 0
2
4
6
8
10
12
Units of labour (L)
14
16
18
20
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – an isoquant map
An isoquant map
Units of capital (K)
30
20
10
I5 I1
0 0
10
Units of labour (L)
I2 20
I3
I4
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale
An isoquant map
Units of capital (K)
30
20
10
I5 I1
0 0
10
Units of labour (L)
I2 20
I3
I4
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale – isoquants and marginal returns
Diminishing marginal rate of factor substitution 14
g
Units of capital (K)
12 ∆K = 2
MRS = ∆K / ∆L
MRS = 2 h
10 ∆L = 1
8
j
MRS = 1 k
∆K = 1
6
∆L = 1
4 2
isoquant
0 0
2
4
6
8
10
12
Units of labour (L)
14
16
18
20
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale – isoquants and marginal returns
• Isocosts
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale – isoquants and marginal returns
• Isocosts – slope and position of the isocost
An isocost
30
Assumptions
Units of capital (K)
25
PK = £20 000 W = £10 000 TC = £300 000
20
15
10
5
0 0
5
10
15
20
25
Units of labour (L)
30
35
40
An isocost
30
Assumptions
Units of capital (K)
25
PK = £20 000 W = £10 000 TC = £300 000
20
a
15
b
10
c
5
TC = £300 000 d
0 0
5
10
15
20
25
Units of labour (L)
30
35
40
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale – isoquants and marginal returns
• Isocosts – slope and position of the isocost – shifts in the isocost
ISOQUANT- ISOCOST ANALYSIS • Least-cost combination of factors for a given output – point of tangency
Finding the least-cost method of production
35
Assumptions
Units of capital (K)
30
PK = £20 000 W = £10 000
25
TC = £200 000 TC = £300 000
20 15
TC = £400 000 10
TC = £500 000
5 0 0
10
20
30
Units of labour (L)
40
50
Finding the least-cost method of production
35
Units of capital (K)
30 25
s
TC = £500 000
20 15
TC = £400 000
r
10
t
5
TPP1
0 0
10
20
30
Units of labour (L)
40
50
ISOQUANT- ISOCOST ANALYSIS • Least-cost combination of factors for a given output – point of tangency – comparison with marginal productivity approach
ISOQUANT- ISOCOST ANALYSIS • Least-cost combination of factors for a given output – point of tangency – comparison with marginal productivity approach
• Highest output for a given cost of production
Units of capital (K)
Finding the maximum output for a given total cost
TPP5 TPP4 TPP3 TPP2
TPP1
O Units of labour (L)
Units of capital (K)
Finding the maximum output for a given total cost
Isocost
TPP5 TPP4 TPP3 TPP2
TPP1
O Units of labour (L)
Finding the maximum output for a given total cost r Units of capital (K)
s
u v
TPP5 TPP4 TPP3 TPP2
TPP1
O Units of labour (L)
Finding the maximum output for a given total cost r Units of capital (K)
s
K1
t
u v O
TPP5 TPP4 TPP3 TPP2
TPP1 L1 Units of labour (L)
Background to Supply
Long-run Costs
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
Costs
Alternative long-run average cost curves
Economies of Scale
LRAC
O
Output
Alternative long-run average cost curves
Costs
LRAC
O
Diseconomies of Scale
Output
Costs
Alternative long-run average cost curves
O
Constant costs LRAC
Output
A typical long-run average cost curve
Costs
LRAC
O
Output
Costs
A typical long-run average cost curve
O
Economies of scale
Constant costs
Output
Diseconomies of scale
LRAC
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs
Costs
Long-run average and marginal costs
Economies of Scale
LRAC LRMC O
Output
Long-run average and marginal costs
Costs
LRMC
O
Diseconomies of Scale
Output
LRAC
Costs
Long-run average and marginal costs
O
Constant costs LRAC = LRMC
Output
Long-run average and marginal costs
Initial economies of scale, then diseconomies of scale
LRAC
Costs O
LRMC
Output
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs – the envelope curve
Deriving long-run average cost curves: factories of fixed size
Costs
SRAC1 SRAC 2
SRAC3
1 factory 2 factories 3 factories4 factories
O
Output
SRAC5 SRAC4
5 factories
Deriving long-run average cost curves: factories of fixed size SRAC1 SRAC 2
SRAC3
SRAC5 SRAC4
Costs
LRAC
O
Output
Costs
Deriving a long-run average cost curve: choice of factory size
Examples of short-run average cost curves
O
Output
Deriving a long-run average cost curve: choice of factory size
Costs
LRAC
O
Output
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs – the envelope curve
• Long-run cost curves in practice
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs – the envelope curve
• Long-run cost curves in practice – the evidence
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs – the envelope curve
• Long-run cost curves in practice – the evidence – minimum efficient plant size
LONG-RUN COSTS • Derivation of long-run costs from an isoquant map – derivation of long-run costs
Units of capital (K)
Deriving an LRAC curve from an isoquant map
At an output of 200 LRAC = TC2 / 200
100 200 1
2 TC
TC
O
Units of labour (L)
Deriving an LRAC curve from an isoquant map
Units of capital (K)
Note: increasing returns to scale up to 400 units; decreasing returns to scale above 400 units
700
100 200
TC 7
6 TC
Units of labour (L)
5 TC
2
4
TC
1
TC 3 TC
TC
O
600 500 400 300
LONG-RUN COSTS • Derivation of long-run costs from an isoquant map – derivation of long-run costs – the expansion path
Units of capital (K)
Deriving an LRAC curve from an isoquant map
Expansion path
700
100 200
TC 7
6 TC
Units of labour (L)
5 TC
2
4
TC
1
TC 3 TC
TC
O
600 500 400 300
Background to Supply
Revenue
REVENUE • Defining total, average and marginal revenue • Revenue curves when firms are price takers (horizontal demand curve) – average revenue (AR) – marginal revenue (MR)
S
AR, MR (£)
Price (£)
Deriving a firm’s AR and MR: price-taking firm
Pe
D O
Q (millions)
(a) The market
O
Q (hundreds)
(b) The firm
S
AR, MR (£)
Price (£)
Deriving a firm’s AR and MR: price-taking firm
D = AR = MR
Pe
D O
Q (millions)
(a) The market
O
Q (hundreds)
(b) The firm
REVENUE • Defining total, average and marginal revenue • Revenue curves when firms are price takers (horizontal demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR)
Total revenue for a price-taking firm Quantity Price = AR (units) = MR (£)
6000
0 200 400 600 800 1000 1200
TR (£)
5000 4000 3000
5 5 5 5 5 5 5
2000 1000 0 0
200
400
600
Quantity
800
1000
1200
Total revenue for a price-taking firm Quantity Price = AR (units) = MR (£)
6000
0 200 400 600 800 1000 1200
TR (£)
5000 4000 3000
5 5 5 5 5 5 5
TR (£) 0 1000 2000 3000 4000 5000 6000
2000 1000 0 0
200
400
600
Quantity
800
1000
1200
Total revenue for a price-taking firm Quantity Price = AR (units) = MR (£)
6000
0 200 400 600 800 1000 1200
TR (£)
5000 4000 3000
5 5 5 5 5 5 5
TR
TR (£) 0 1000 2000 3000 4000 5000 6000
2000 1000 0 0
200
400
600
Quantity
800
1000
1200
Total revenue for a price-taking firm TR
6000
TR (£)
5000 4000 3000 2000 1000 0 0
200
400
600
Quantity
800
1000
1200
REVENUE • Revenue curves when price varies with output (downward-sloping demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR)
Revenues for a firm facing a downward-sloping demand curve
Revenues for a firm facing a downward-sloping demand curve
Revenues for a firm facing a downward-sloping demand curve
AR and MR curves for a firm facing a downward-sloping D curve Q P (units) =AR (£) 8 1 7 2 6 3 5 4 4 5 3 6 2 7
8
AR, MR (£)
6
4
2
AR
0 1 -2
-4
2
3
4
5
6
7
Quantity
AR and MR curves for a firm facing a downward-sloping D curve Q P (units) =AR (£) 8 1 7 2 6 3 5 4 4 5 3 6 2 7
8
AR, MR (£)
6
4
2
TR MR (£) (£) 8 6 14 4 18 2 20 0 20 -2 18 -4 14
AR
0 1
2
3
4
5
6
7
-2
-4
MR
Quantity
REVENUE • Revenue curves when price varies with output (downward-sloping demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR)
TR curve for a firm facing a downward-sloping D curve 20
16
Quantity P = AR (units) (£)
TR (£)
12
1 2 3 4 5 6 7
8
4
TR (£)
8 7 6 5 4 3 2
8 14 18 20 20 18 14
5
6
0 0
1
2
3
4
Quantity
7
TR curve for a firm facing a downward-sloping D curve 20
16
Quantity P = AR (units) (£)
TR (£)
12
1 2 3 4 5 6 7
8
4
TR
TR (£)
8 7 6 5 4 3 2
8 14 18 20 20 18 14
5
6
0 0
1
2
3
4
Quantity
7
REVENUE • Revenue curves when price varies with output (downward-sloping demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR) – revenue curves and price elasticity of demand
TR curve for a firm facing a downward-sloping D curve Elasticity = -1 20
tic
El
as
as
el
tic
In
16
TR
TR (£)
12
8
4
0 0
1
2
3
4
Quantity
5
6
7
AR and MR curves for a firm facing a downward-sloping D curve 8
Elastic Elasticity = -1
AR, MR (£)
6
4
Inelastic
2
AR
0 1
2
3
4
5
6
7
-2
-4
MR
Quantity
REVENUE • Revenue curves when price varies with output (downward-sloping demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR) – revenue curves and price elasticity of demand
• Shifts in revenue curves
Background to Supply
Profit Maximisation
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC
Finding maximum profit using total curves 24
TR, TC, TΠ (£)
20 16 12 8 4 0 1 -4 -8
2
3
4
5
6
7
Quantity
Finding maximum profit using total curves 24
TR, TC, TΠ (£)
20 16
TR
12 8 4 0 1 -4 -8
2
3
4
5
6
7
Quantity
Finding maximum profit using total curves TC
24
TR, TC, TΠ (£)
20 16
TR
12 8 4 0 1 -4 -8
2
3
4
5
6
7
Quantity
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC – the total profit curve
Finding maximum profit using total curves TC
24
TR, TC, TΠ (£)
20 16
TR
12 8 4 0 1
2
3
4
5
6
-4 -8
TΠ
7
Quantity
Finding maximum profit using total curves TC
24
b
TR, TC, TΠ (£)
20 16
TR
a
12 8 4
c
0 1
d 2
3
4
5
6
-4 -8
TΠ
7
Quantity
TR, TC, TΠ (£)
Finding maximum profit using total curves 24 22 20 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8
TC d
TR
e
f
1
2
3
4
5
6
TΠ
7
Quantity
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC – the total profit curve
• Using marginal and average curves
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC – the total profit curve
• Using marginal and average curves – stage 1:
profit maximised where MR = MC
Finding the profit-maximising output using marginal curves 16
Costs and revenue (£)
12
8
4
0 1 -4
2
3
4
5
6
7
Quantity
Finding the profit-maximising output using marginal curves 16 MC
Costs and revenue (£)
12
8
4
0 1 -4
2
3
4
5
6
7
Quantity
Finding the profit-maximising output using marginal curves 16 MC
Costs and revenue (£)
12
8
4
Profit-maximising output
e
0 1 -4
2
3
4
5
6
7
MR
Quantity
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC – the total profit curve
• Using marginal and average curves – stage 1:
profit maximised where MR = MC
– stage 2:
using AR and AC curves to measure maximum profit
Measuring the maximum profit using average curves 16
MC
Costs and revenue (£)
12
8
4
0 1 -4
2
3
4
5
6
7
MR
Quantity
Measuring the maximum profit using average curves 16
MC
Costs and revenue (£)
12
8
4
AR 0 1 -4
2
3
4
5
6
7
MR
Quantity
Measuring the maximum profit using average curves 16
MC Total profit = £1.50 x 3 = £4.50
Costs and revenue (£)
12
AC
8
a
6.00 TOTAL PROFIT b 4.50 4
AR 0 1 -4
2
3
4
5
6
7
MR
Quantity
PROFIT MAXIMISATION • Some qualifications – long-run profit maximisation – the meaning of profit
• What if a loss is made? – loss minimising:
still produce where MR = MC
Loss-minimising output MC
Costs and revenue (£)
AC
AC
LOSS AR
AR O
Q
MR
Quantity
PROFIT MAXIMISATION • Some qualifications – long-run profit maximisation – the meaning of profit
• What if a loss is made? – loss minimising:
still produce where MR = MC
– short-run shut-down point: P = AVC
Costs and revenue (£)
The short-run shut-down point
AC AVC
P= AVC
AR O
Q Quantity
PROFIT MAXIMISATION • Some qualifications – long-run profit maximisation – the meaning of profit
• What if a loss is made? – loss minimising:
still produce where MR = MC
– short-run shut-down point: P = AVC
– long-run shut-down point: P = LRAC
Background to Supply
The Short-run Theory of Production
SHORT-RUN THEORY OF PRODUCTION • Profits and the aims of the firm • Long-run and short-run production: – fixed and variable factors
• The law of diminishing returns • The short-run production function: – total physical product (TPP) – average physical product (APP) APP = TPP/QV – marginal physical product (MPP) MPP = ∆TPP/∆QV
Wheat production per year from a particular farm (tonnes)
Wheat production per year from a particular farm (tonnes)
Wheat production per year from a particular farm (tonnes)
Wheat production per year from a particular farm (tonnes)
SHORT-RUN THEORY OF PRODUCTION • Profits and the aims of the firm • Long-run and short-run production: – fixed and variable factors
• The law of diminishing returns • The short-run production function: – total physical product (TPP) – average physical product (APP) APP = TPP/QV – marginal physical product (MPP) MPP = ∆TPP/∆QV – graphical relationship between TPP, APP and MPP
Wheat production per year from a particular farm Number of workers 0 1 2 3 4 5 6 7 8
Tonnes of wheat produced per year
40
30
20
TPP 0 3 10 24 36 40 42 42 40
10
0 0
1
2
3
4
5
Number of farm workers
6
7
8
Wheat production per year from a particular farm Number of workers 0 1 2 3 4 5 6 7 8
Tonnes of wheat produced per year
40
30
20
TPP 0 3 10 24 36 40 42 42 40
10
0 0
1
2
3
4
5
Number of farm workers
6
7
8
Wheat production per year from a particular farm d Tonnes of wheat produced per year
40
TPP Maximum output
30
Diminishing returns set in here
20
b
10
0 0
1
2
3
4
5
Number of farm workers
6
7
8
Tonnes of wheat per year
Wheat production per year from a particular farm 40
TPP 30
20
10
∆TPP = 7 0
Tonnes of wheat per year
6
7
8
Number of farm workers (L)
6
7
8
Number of farm workers (L)
0 1
2
3
4
5
∆L = 1
14 12 10 8
MPP = ∆TPP / ∆L = 7
6 4 2 0 -2
0
1
2
3
4
5
Tonnes of wheat per year
Tonnes of wheat per year
Wheat production per year from a particular farm 40
TPP 30
20
10
0
1
2
3
4
5
6
7
8
Number of farm workers (L)
0
1
2
3
4
5
6
7
8
Number of farm workers (L)
0
14 12 10 8 6 4 2 0 -2
MPP
Tonnes of wheat per year
Wheat production per year from a particular farm 40
TPP 30
20
10
0
Tonnes of wheat per year
0
1
2
3
4
5
6
7
8
Number of farm workers (L)
14
APP = TPP / L
12 10 8 6
APP
4 2 0 -2
0
1
2
3
4
5
6
7
8
MPP
Number of farm workers (L)
Tonnes of wheat per year
Wheat production per year from a particular farm 40
TPP 30
b
20
10
0 0
Tonnes of wheat per year
Diminishing returns set in here
1
2
3
4
5
6
7
8
Number of farm workers (L)
b
14 12 10 8 6
APP
4 2 0 -2
0
1
2
3
4
5
6
7
8
MPP
Number of farm workers (L)
Wheat production per year from a particular farm Tonnes of wheat per year
d
40
TPP 30
20
10
0 0
Tonnes of wheat per year
Maximum output
b
1
2
3
4
5
6
7
8
Number of farm workers (L)
b
14 12 10 8 6
APP
4 2
d
0 -2
0
1
2
3
4
5
6
7
8
MPP
Number of farm workers (L)
Wheat production per year from a particular farm Tonnes of wheat per year
d
Slope = TPP / L = APP
40
TPP
30
20
b
10
0 0
Tonnes of wheat per year
c
1
2
3
4
5
6
7
8
Number of farm workers (L)
b
14 12 10
c
8 6 4
APP
2
d
0 -2
0
1
2
3
4
5
6
7
8
MPP
Number of farm workers (L)
Background to Supply
Short-run Costs
SHORT-RUN COSTS • Measuring costs of production: opportunity costs – explicit costs – implicit costs
• Fixed costs and variable costs • Total costs – total fixed cost (TFC) – total variable cost (TVC) – total cost (TC = TFC + TVC)
Total costs for firm X
Output TFC (Q) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
40
20
0 0
1
2
3
4
5
6
7
8
Total costs for firm X
Output TFC (Q) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Total costs for firm X
Output TFC TVC (Q) (£) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
0 10 16 21 28 40 60 91
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Total costs for firm X
Output TFC TVC (Q) (£) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
0 10 16 21 28 40 60 91
TVC
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Output TFC TVC (Q) (£) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
TC (£)
0 10 16 21 28 40 60 91
Total costs for firm X
12 22 28 33 40 52 72 103
TVC
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Output TFC TVC (Q) (£) (£)
100
0 1 2 3 4 5 6 7
80
60
12 12 12 12 12 12 12 12
TC (£)
0 10 16 21 28 40 60 91
Total costs for firm X TC
12 22 28 33 40 52 72 103
TVC
40
20
TFC 0 0
1
2
3
4
5
6
7
8
Total costs for firm X TC
100
TVC 80
Diminishing marginal returns set in here
60
40
20
TFC 0 0
1
2
3
4
5
6
7
8
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns
Average and marginal physical product
Output
b
Diminishing returns set in here
MPP
Quantity of the variable factor
Average and marginal physical product b
Output
c
APP
MPP
Quantity of the variable factor
Marginal cost
Costs (£)
MC
Diminishing marginal returns set in here
x
Output (Q)
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
Total costs for firm X TC
100
TVC 80
Bottom of the MC curve
60
40
20
TFC 0 0
1
2
3
4
5
6
7
8
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost – average fixed cost (AFC)
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost – average fixed cost (AFC) – average variable cost (AVC)
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost – average fixed cost (AFC) – average variable cost (AVC) – average (total) cost (AC)
SHORT-RUN COSTS • Marginal cost – marginal cost (MC) and the law of diminishing returns – the relationship between the marginal and total cost curves
• Average cost – average fixed cost (AFC) – average variable cost (AVC) – average (total) cost (AC) – relationship between AC and MC
Average and marginal costs MC
AC
Costs (£)
AVC
z y x AFC
Output (Q)
Background to Supply
The Long-run Theory of Production
LONG-RUN THEORY OF PRODUCTION • All factors variable in long run • The scale of production: – constant returns to scale – increasing returns to scale – decreasing returns to scale
Short-run and long-run increases in output
LONG-RUN THEORY OF PRODUCTION • Economies of scale – specialisation & division of labour – indivisibilities – container principle – greater efficiency of large machines – by-products – multi-stage production – organisational & administrative economies – financial economies – economies of scope
LONG-RUN THEORY OF PRODUCTION • Diseconomies of scale • External economies and diseconomies of scale • Optimum combination of factors MPPa/Pa = MPPb/Pb ... = MPPn/Pn
Background to Supply
Isoquant–Isocost Analysis
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape
An isoquant 45 40
Units of K 40 20 10 6 4
Units of capital (K)
35 30 25
Units of L 5 12 20 30 50
Point on diagram a b c d e
20 15 10 5 0 0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
An isoquant 45
a
40
Units of K 40 20 10 6 4
Units of capital (K)
35 30 25
Units of L 5 12 20 30 50
Point on diagram a b c d e
20 15 10 5 0 0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
An isoquant 45
a
40
Units of K 40 20 10 6 4
Units of capital (K)
35 30 25
Units of L 5 12 20 30 50
Point on diagram a b c d e
b
20 15 10 5 0 0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
An isoquant 45
a
40
Units of K 40 20 10 6 4
Units of capital (K)
35 30 25
Units of L 5 12 20 30 50
Point on diagram a b c d e
b
20 15
c
10
d
e
5 0 0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution
Diminishing marginal rate of factor substitution 14
g
Units of capital (K)
12 ∆K = 2
MRS = ∆K / ∆L
MRS = 2 h
10 ∆L = 1
8 6 4 2
isoquant
0 0
2
4
6
8
10
12
14
Units of labour (L)
16
18
20
22
Diminishing marginal rate of factor substitution 14
g
Units of capital (K)
12 ∆K = 2
MRS = ∆K / ∆L
MRS = 2 h
10 ∆L = 1
8
j
MRS = 1 k
∆K = 1
6
∆L = 1
4 2
isoquant
0 0
2
4
6
8
10
12
Units of labour (L)
14
16
18
20
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – an isoquant map
An isoquant map
Units of capital (K)
30
20
10
I5 I1
0 0
10
Units of labour (L)
I2 20
I3
I4
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale
An isoquant map
Units of capital (K)
30
20
10
I5 I1
0 0
10
Units of labour (L)
I2 20
I3
I4
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale – isoquants and marginal returns
Diminishing marginal rate of factor substitution 14
g
Units of capital (K)
12 ∆K = 2
MRS = ∆K / ∆L
MRS = 2 h
10 ∆L = 1
8
j
MRS = 1 k
∆K = 1
6
∆L = 1
4 2
isoquant
0 0
2
4
6
8
10
12
Units of labour (L)
14
16
18
20
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale – isoquants and marginal returns
• Isocosts
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale – isoquants and marginal returns
• Isocosts – slope and position of the isocost
An isocost
30
Assumptions
Units of capital (K)
25
PK = £20 000 W = £10 000 TC = £300 000
20
15
10
5
0 0
5
10
15
20
25
Units of labour (L)
30
35
40
An isocost
30
Assumptions
Units of capital (K)
25
PK = £20 000 W = £10 000 TC = £300 000
20
a
15
b
10
c
5
TC = £300 000 d
0 0
5
10
15
20
25
Units of labour (L)
30
35
40
ISOQUANT- ISOCOST ANALYSIS • Isoquants – their shape – diminishing marginal rate of substitution – isoquants and returns to scale – isoquants and marginal returns
• Isocosts – slope and position of the isocost – shifts in the isocost
ISOQUANT- ISOCOST ANALYSIS • Least-cost combination of factors for a given output – point of tangency
Finding the least-cost method of production
35
Assumptions
Units of capital (K)
30
PK = £20 000 W = £10 000
25
TC = £200 000 TC = £300 000
20 15
TC = £400 000 10
TC = £500 000
5 0 0
10
20
30
Units of labour (L)
40
50
Finding the least-cost method of production
35
Units of capital (K)
30 25
s
TC = £500 000
20 15
TC = £400 000
r
10
t
5
TPP1
0 0
10
20
30
Units of labour (L)
40
50
ISOQUANT- ISOCOST ANALYSIS • Least-cost combination of factors for a given output – point of tangency – comparison with marginal productivity approach
ISOQUANT- ISOCOST ANALYSIS • Least-cost combination of factors for a given output – point of tangency – comparison with marginal productivity approach
• Highest output for a given cost of production
Units of capital (K)
Finding the maximum output for a given total cost
TPP5 TPP4 TPP3 TPP2
TPP1
O Units of labour (L)
Units of capital (K)
Finding the maximum output for a given total cost
Isocost
TPP5 TPP4 TPP3 TPP2
TPP1
O Units of labour (L)
Finding the maximum output for a given total cost r Units of capital (K)
s
u v
TPP5 TPP4 TPP3 TPP2
TPP1
O Units of labour (L)
Finding the maximum output for a given total cost r Units of capital (K)
s
K1
t
u v O
TPP5 TPP4 TPP3 TPP2
TPP1 L1 Units of labour (L)
Background to Supply
Long-run Costs
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
Costs
Alternative long-run average cost curves
Economies of Scale
LRAC
O
Output
Alternative long-run average cost curves
Costs
LRAC
O
Diseconomies of Scale
Output
Costs
Alternative long-run average cost curves
O
Constant costs LRAC
Output
A typical long-run average cost curve
Costs
LRAC
O
Output
Costs
A typical long-run average cost curve
O
Economies of scale
Constant costs
Output
Diseconomies of scale
LRAC
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs
Costs
Long-run average and marginal costs
Economies of Scale
LRAC LRMC O
Output
Long-run average and marginal costs
Costs
LRMC
O
Diseconomies of Scale
Output
LRAC
Costs
Long-run average and marginal costs
O
Constant costs LRAC = LRMC
Output
Long-run average and marginal costs
Initial economies of scale, then diseconomies of scale
LRAC
Costs O
LRMC
Output
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs – the envelope curve
Deriving long-run average cost curves: factories of fixed size
Costs
SRAC1 SRAC 2
SRAC3
1 factory 2 factories 3 factories4 factories
O
Output
SRAC5 SRAC4
5 factories
Deriving long-run average cost curves: factories of fixed size SRAC1 SRAC 2
SRAC3
SRAC5 SRAC4
Costs
LRAC
O
Output
Costs
Deriving a long-run average cost curve: choice of factory size
Examples of short-run average cost curves
O
Output
Deriving a long-run average cost curve: choice of factory size
Costs
LRAC
O
Output
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs – the envelope curve
• Long-run cost curves in practice
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs – the envelope curve
• Long-run cost curves in practice – the evidence
LONG-RUN COSTS • Long-run average costs – shape of the LRAC curve – assumptions behind the curve
• Long-run marginal costs • Relationship between long-run and short-run average costs – the envelope curve
• Long-run cost curves in practice – the evidence – minimum efficient plant size
LONG-RUN COSTS • Derivation of long-run costs from an isoquant map – derivation of long-run costs
Units of capital (K)
Deriving an LRAC curve from an isoquant map
At an output of 200 LRAC = TC2 / 200
100 200 1
2 TC
TC
O
Units of labour (L)
Deriving an LRAC curve from an isoquant map
Units of capital (K)
Note: increasing returns to scale up to 400 units; decreasing returns to scale above 400 units
700
100 200
TC 7
6 TC
Units of labour (L)
5 TC
2
4
TC
1
TC 3 TC
TC
O
600 500 400 300
LONG-RUN COSTS • Derivation of long-run costs from an isoquant map – derivation of long-run costs – the expansion path
Units of capital (K)
Deriving an LRAC curve from an isoquant map
Expansion path
700
100 200
TC 7
6 TC
Units of labour (L)
5 TC
2
4
TC
1
TC 3 TC
TC
O
600 500 400 300
Background to Supply
Revenue
REVENUE • Defining total, average and marginal revenue • Revenue curves when firms are price takers (horizontal demand curve) – average revenue (AR) – marginal revenue (MR)
S
AR, MR (£)
Price (£)
Deriving a firm’s AR and MR: price-taking firm
Pe
D O
Q (millions)
(a) The market
O
Q (hundreds)
(b) The firm
S
AR, MR (£)
Price (£)
Deriving a firm’s AR and MR: price-taking firm
D = AR = MR
Pe
D O
Q (millions)
(a) The market
O
Q (hundreds)
(b) The firm
REVENUE • Defining total, average and marginal revenue • Revenue curves when firms are price takers (horizontal demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR)
Total revenue for a price-taking firm Quantity Price = AR (units) = MR (£)
6000
0 200 400 600 800 1000 1200
TR (£)
5000 4000 3000
5 5 5 5 5 5 5
2000 1000 0 0
200
400
600
Quantity
800
1000
1200
Total revenue for a price-taking firm Quantity Price = AR (units) = MR (£)
6000
0 200 400 600 800 1000 1200
TR (£)
5000 4000 3000
5 5 5 5 5 5 5
TR (£) 0 1000 2000 3000 4000 5000 6000
2000 1000 0 0
200
400
600
Quantity
800
1000
1200
Total revenue for a price-taking firm Quantity Price = AR (units) = MR (£)
6000
0 200 400 600 800 1000 1200
TR (£)
5000 4000 3000
5 5 5 5 5 5 5
TR
TR (£) 0 1000 2000 3000 4000 5000 6000
2000 1000 0 0
200
400
600
Quantity
800
1000
1200
Total revenue for a price-taking firm TR
6000
TR (£)
5000 4000 3000 2000 1000 0 0
200
400
600
Quantity
800
1000
1200
REVENUE • Revenue curves when price varies with output (downward-sloping demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR)
Revenues for a firm facing a downward-sloping demand curve
Revenues for a firm facing a downward-sloping demand curve
Revenues for a firm facing a downward-sloping demand curve
AR and MR curves for a firm facing a downward-sloping D curve Q P (units) =AR (£) 8 1 7 2 6 3 5 4 4 5 3 6 2 7
8
AR, MR (£)
6
4
2
AR
0 1 -2
-4
2
3
4
5
6
7
Quantity
AR and MR curves for a firm facing a downward-sloping D curve Q P (units) =AR (£) 8 1 7 2 6 3 5 4 4 5 3 6 2 7
8
AR, MR (£)
6
4
2
TR MR (£) (£) 8 6 14 4 18 2 20 0 20 -2 18 -4 14
AR
0 1
2
3
4
5
6
7
-2
-4
MR
Quantity
REVENUE • Revenue curves when price varies with output (downward-sloping demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR)
TR curve for a firm facing a downward-sloping D curve 20
16
Quantity P = AR (units) (£)
TR (£)
12
1 2 3 4 5 6 7
8
4
TR (£)
8 7 6 5 4 3 2
8 14 18 20 20 18 14
5
6
0 0
1
2
3
4
Quantity
7
TR curve for a firm facing a downward-sloping D curve 20
16
Quantity P = AR (units) (£)
TR (£)
12
1 2 3 4 5 6 7
8
4
TR
TR (£)
8 7 6 5 4 3 2
8 14 18 20 20 18 14
5
6
0 0
1
2
3
4
Quantity
7
REVENUE • Revenue curves when price varies with output (downward-sloping demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR) – revenue curves and price elasticity of demand
TR curve for a firm facing a downward-sloping D curve Elasticity = -1 20
tic
El
as
as
el
tic
In
16
TR
TR (£)
12
8
4
0 0
1
2
3
4
Quantity
5
6
7
AR and MR curves for a firm facing a downward-sloping D curve 8
Elastic Elasticity = -1
AR, MR (£)
6
4
Inelastic
2
AR
0 1
2
3
4
5
6
7
-2
-4
MR
Quantity
REVENUE • Revenue curves when price varies with output (downward-sloping demand curve) – average revenue (AR) – marginal revenue (MR) – total revenue (TR) – revenue curves and price elasticity of demand
• Shifts in revenue curves
Background to Supply
Profit Maximisation
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC
Finding maximum profit using total curves 24
TR, TC, TΠ (£)
20 16 12 8 4 0 1 -4 -8
2
3
4
5
6
7
Quantity
Finding maximum profit using total curves 24
TR, TC, TΠ (£)
20 16
TR
12 8 4 0 1 -4 -8
2
3
4
5
6
7
Quantity
Finding maximum profit using total curves TC
24
TR, TC, TΠ (£)
20 16
TR
12 8 4 0 1 -4 -8
2
3
4
5
6
7
Quantity
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC – the total profit curve
Finding maximum profit using total curves TC
24
TR, TC, TΠ (£)
20 16
TR
12 8 4 0 1
2
3
4
5
6
-4 -8
TΠ
7
Quantity
Finding maximum profit using total curves TC
24
b
TR, TC, TΠ (£)
20 16
TR
a
12 8 4
c
0 1
d 2
3
4
5
6
-4 -8
TΠ
7
Quantity
TR, TC, TΠ (£)
Finding maximum profit using total curves 24 22 20 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8
TC d
TR
e
f
1
2
3
4
5
6
TΠ
7
Quantity
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC – the total profit curve
• Using marginal and average curves
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC – the total profit curve
• Using marginal and average curves – stage 1:
profit maximised where MR = MC
Finding the profit-maximising output using marginal curves 16
Costs and revenue (£)
12
8
4
0 1 -4
2
3
4
5
6
7
Quantity
Finding the profit-maximising output using marginal curves 16 MC
Costs and revenue (£)
12
8
4
0 1 -4
2
3
4
5
6
7
Quantity
Finding the profit-maximising output using marginal curves 16 MC
Costs and revenue (£)
12
8
4
Profit-maximising output
e
0 1 -4
2
3
4
5
6
7
MR
Quantity
PROFIT MAXIMISATION • Using total curves – maximising difference between TR and TC – the total profit curve
• Using marginal and average curves – stage 1:
profit maximised where MR = MC
– stage 2:
using AR and AC curves to measure maximum profit
Measuring the maximum profit using average curves 16
MC
Costs and revenue (£)
12
8
4
0 1 -4
2
3
4
5
6
7
MR
Quantity
Measuring the maximum profit using average curves 16
MC
Costs and revenue (£)
12
8
4
AR 0 1 -4
2
3
4
5
6
7
MR
Quantity
Measuring the maximum profit using average curves 16
MC Total profit = £1.50 x 3 = £4.50
Costs and revenue (£)
12
AC
8
a
6.00 TOTAL PROFIT b 4.50 4
AR 0 1 -4
2
3
4
5
6
7
MR
Quantity
PROFIT MAXIMISATION • Some qualifications – long-run profit maximisation – the meaning of profit
• What if a loss is made? – loss minimising:
still produce where MR = MC
Loss-minimising output MC
Costs and revenue (£)
AC
AC
LOSS AR
AR O
Q
MR
Quantity
PROFIT MAXIMISATION • Some qualifications – long-run profit maximisation – the meaning of profit
• What if a loss is made? – loss minimising:
still produce where MR = MC
– short-run shut-down point: P = AVC
Costs and revenue (£)
The short-run shut-down point
AC AVC
P= AVC
AR O
Q Quantity
PROFIT MAXIMISATION • Some qualifications – long-run profit maximisation – the meaning of profit
• What if a loss is made? – loss minimising:
still produce where MR = MC
– short-run shut-down point: P = AVC
– long-run shut-down point: P = LRAC
Related Documents
Background To Supply
November 2019 9
Background To Malaria - Edited
May 2020 5
Background To The Dff
April 2020 21
Background To Demand
November 2019 4
Background
November 2019 39