AP CALCULUS – Applications in Economics

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The Calculus of fundamental functions in Firm Theory
Variable Mathematical Expression
Quantity (horizontal axis) x
Total cost (TC) C ( x)
Marginal cost (MC) MC  C '( x)
Average Cost (AC) C ( x)
AC 
x
Price function (demand) p( x)
Total revenue (R) R( x)  xp( x)
Marginal Revenue (MR) MR  R '( x)
Profit (P) P( x)  R  TC  xp( x)  C ( x)

Two different firm behaviors:

A. To produce at a minimum average cost, one must minimize AC:

C ( x)
AC   AC '  0
x
xC '( x)  C ( x)
 AC '  0
x2
 xC '( x)  C ( x)  0
 xC '( x)  C ( x)
C ( x)
 C '( x) 
x
 MC  AC
 Firm must produce at the level where marginal cost equals average cost.

B. A profit-maximizing firm would maximize its profit function:

max P( x)  P '( x)  0
 [ R( x)  C ( x)]'  0
 R '( x)  C '( x)  0
 MR( x)  MC ( x)  0
 MR( x)  MC ( x)
 Firm must produce at the level where marginal revenue equals marginal cost.

 Use the profit-maximizing rule of thumb with caution. One of the derivative
tests (first or second) must be used to verify that the critical point is a
maximum point and not a min.