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CFO CH 8
CFO CH 8
Output Decisions
8
CHAPTER OUTLINE
Costs in the Short Run
Fixed Costs
Variable Costs
Total Costs
Short-Run Costs: A Review
Looking Ahead
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fixed cost Any cost that does not depend on the firms
level of output. These costs are incurred even if the firm
is producing nothing. There are no fixed costs in the long
run.
variable cost A cost that depends on the level of
production chosen.
total cost (TC) Total fixed costs plus total variable costs.
TC = TFC + TVC
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(2)
TFC
$1,000
1,000
1,000
1,000
1,000
1,000
(3)
AFC (TFC/q)
$
1,000
500
333
250
200
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TFC
AFC =
q
spreading overhead The process of dividing total
fixed costs by more units of output. Average fixed
cost declines as quantity rises.
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TABLE 8.2 Derivation of Total Variable Cost Schedule from Technology and Factor Prices
Produce
1 unit of
output
2 units of
output
3 units of
output
Using
Technique
(4 x $2) + (4 x $1)
= $12
(2 x $2) + (6 x $1)
= $10
(7 x $2) + (6 x $1)
= $20
10
14
= $24
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0
1
2
3
0
10
18
24
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slope of TVC =
TVC TVC
=
= TVC = MC
q
1
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TVC
AVC =
q
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(2)
TVC
(3)
MC
( TVC)
(4)
AVC
(TVC/q)
(5)
TFC
(6)
TC
(TVC + TFC)
$1,000
$ 1,000
(7)
AFC
(TFC/q)
10
10
10
1,000
1,010
1,000
1,010
18
1,000
1,018
500
509
24
1,000
1,024
333
341
32
1,000
1,032
250
258
42
10
8.4
1,000
1,042
200
208.4
500
8,000
20
16
1,000
9,000
(8)
ATC
(TC/q or AFC + AVC)
$
18
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TC
ATC =
q
ATC = AFC + AVC
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Definition
Equation
Accounting costs
Economic costs
AFC = TFC/q
AVC = TVC/q
TC = TFC + TVC
EC ON OMIC S IN PRACTIC E
Average and Marginal Costs at a College
Students
Costs in Dollars
Total Fixed Cost Total Variable Cost Total Cost
500
$60 million
$ 20 million
$ 80 million
$160,000
1,000
60 million
40 million
100 million
100,000
1,500
60 million
60 million
120 million
80.000
2,000
60 million
80 million
140 million
70,000
2,500
60 million
100 million
160 million
64,000
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If a representative firm in a perfectly competitive market raises the price of its output above $6.00,
the quantity demanded of that firms output will drop to zero.
Each firm faces a perfectly elastic demand curve, d.
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(2)
(3)
(4)
(5)
TFC
TVC
MC
P = MR
(6)
TR
(P x q)
(7)
TC
(TFC + TVC)
(8)
Profit
(TR TC)
10
$ 10
15
20
15
30
25
15
45
30
15
30
10
15
60
40
20
10
50
20
15
75
60
15
10
80
30
15
90
90
$ 10
15
10
10
10
15
10
15
10
20
10
5
6
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EC ON OMIC S IN PRACTIC E
Case Study in Marginal Analysis: An Ice Cream Parlor
An analysis of fixed
costs; variable
costs; marginal
costs; revenues;
marginal revenues;
and profits were
used by this ice
cream parlor to
determine whether
to stay in business.
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TR = P x Q
TR
Q
AR =
TR
MR =
Q
=P
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Profit Maximization
What Q maximizes the firms profit?
To find the answer, think at the margin.
If increase Q by one unit,
revenue rises by MR,
cost rises by MC.
If MR > MC, then increase Q to raise profit.
If MR < MC, then reduce Q to raise profit.
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Profit Maximization
At any Q with
MR > MC,
increasing Q
raises profit.
At any Q with
MR < MC,
reducing Q
raises profit.
TR
TC
Profit MR MC
$0
$5
$5
10
20
15
30
23
40
33
50
45
Profit =
MR MC
$10
$4
$6
10
10
10
10
10
12
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Costs
So, increase Q
to raise profit.
MC
MR
P1
At Q1, MC = MR.
Changing Q
would lower profit.
Qa Q 1 Qb
Q
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Costs
MC
P2
MR2
P1
MR
Q1
Q2
Q
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Costs
MC
ATC
AVC
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Costs
MC
LRATC
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MR
ATC
profit
profit-maximizing quantity
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loss
MR
Q
loss-minimizing quantity
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As long as P AVC, each firm will produce its profit-maximizing quantity, where MR = MC.
Recall from Chapter 4:
At each price, the market quantity supplied is
the sum of quantities supplied by all firms.
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One firm
MC
P3
P3
P2
P2
AVC
P1
Market
S
P1
10 20 30
Q
(firm)
10,000
Q
(market
)
20,000 30,000
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In the LR, the number of firms can change due to entry & exit.
If existing firms earn positive economic profit,
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Long-run equilibrium:
The process of entry or exit is complete
remaining firms earn zero economic profit.
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One firm
MC
Profit
Market
S1
S2
ATC
P2
P2
P1
P1
Q
(firm)
B
A
long-run
supply
D1
Q1 Q2
Q3
D2
Q
(market)
54
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CONCLUSION:
The Efficiency of a Competitive Market
Profit-maximization:
MC = MR
Perfect competition:
P = MR
MR
ATC
profi
t
Q
FIRMS IN COMPETITIVE MARKETS
profit-maximizing
quantity
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loss
loss per
unit
Q
loss-minimizing
quantity
FIRMS IN COMPETITIVE MARKETS
MR
Q
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