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C hapter 9

C hapter 9. Maximizing Profit. Economic Principles. Entrepreneurial behavior Total revenue, average revenue, and marginal revenue Profit maximization. Economic Principles. Loss minimization The application of the MR = MC rule Corporate empire building. Profit Maximization.

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C hapter 9

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  1. Chapter 9 Maximizing Profit

  2. Economic Principles • Entrepreneurial behavior • Total revenue, average revenue,and marginal revenue • Profit maximization Gottheil - Principles of Economics, 4e

  3. Economic Principles • Loss minimization • The application of the MR = MC rule • Corporate empire building Gottheil - Principles of Economics, 4e

  4. Profit Maximization Profit maximization • The primary goal of a firm: To achieve the most profit possible from its production and sale of goods or services. Gottheil - Principles of Economics, 4e

  5. Entrepreneurs and Profit Making Entrepreneurs must make production decisions that require some degree of expertise in both the mechanics of production and in accounting. Gottheil - Principles of Economics, 4e

  6. Entrepreneurs and Profit Making How do entrepreneurs anticipate what prices will be in the future? • Entrepreneurs rely on their best judgment, sometimes on a sixth sense. Gottheil - Principles of Economics, 4e

  7. Profit Profit • Income earned by entrepreneurs. Gottheil - Principles of Economics, 4e

  8. EXHIBIT 1 AVERAGE TOTAL COST AND MARGINAL COST OF PRODUCING FISH PER FISHING RUN ($ PER FISH)

  9. Exhibit 1: Average Total Cost and Marginal Cost of Producing Fish Per Fishing Run 1. If 11,000 fish are for sale at a price of $0.75, then (using the cost data in Exhibit 1) what is the profit per fish? • Profit per fish is (P - ATC). Gottheil - Principles of Economics, 4e

  10. Exhibit 1: Average Total Cost and Marginal Cost of Producing Fish Per Fishing Run 1. If 11,000 fish are for sale at a price of $0.75, then (using the cost data in Exhibit 1) what is the profit per fish? • Profit/fish = $(0.75 - 0.68) = $0.07. Gottheil - Principles of Economics, 4e

  11. Exhibit 1: Average Total Cost and Marginal Cost of Producing Fish Per Fishing Run 2. What is the total profit from selling 11,000 fish? • Total profit is (P - ATC) × Q. Gottheil - Principles of Economics, 4e

  12. Exhibit 1: Average Total Cost and Marginal Cost of Producing Fish Per Fishing Run 2. What is the total profit from selling 11,000 fish? • Total profit = (0.75 - 0.68) × 11,000 = $770. Gottheil - Principles of Economics, 4e

  13. Exhibit 1: Average Total Cost and Marginal Cost of Producing Fish Per Fishing Run 3. What happens to profit if price rises to $0.80, and 11,000 fish are to be sold? • Total profit at an output level of 11,000 equals (0.80 - 0.68) × 11,000 = $1,320. Gottheil - Principles of Economics, 4e

  14. Exhibit 1: Average Total Cost and Marginal Cost of Producing Fish Per Fishing Run 4. If price rises to $0.80, are fishers better off to increase catch to 12,000 fish? • No. Total profit at an output level of 12,000 equals (0.80 - 0.73) × 12,000 = $840. Gottheil - Principles of Economics, 4e

  15. Exhibit 1: Average Total Cost and Marginal Cost of Producing Fish Per Fishing Run 4. If price rises to $0.80, are fishers better off to increase catch to 12,000 fish? • As output increases, average total cost rises from $0.68 to $0.73. Therefore even though output rises, total profit falls. Gottheil - Principles of Economics, 4e

  16. The MR = MC Rule There are two ways to find the most profitable level of production: • Calculate total profit for each and every output level. • Calculate whether the last unit produced adds to or subtracts from total profit. Gottheil - Principles of Economics, 4e

  17. The MR = MC Rule Total revenue (TR) • The price of a good multiplied by the number of units sold. • TR = P × Q Gottheil - Principles of Economics, 4e

  18. The MR = MC Rule Average revenue (AR) • Total revenue divided by the quantity of goods or services sold. • AR = TR/Q Gottheil - Principles of Economics, 4e

  19. The MR = MC Rule If TR = $22,600, and Q = 200, what is AR? • AR = ($22,600/200) = $113. Gottheil - Principles of Economics, 4e

  20. The MR = MC Rule Marginal revenue (MR) • The change in total revenue generated by the sale of one additional unit of goods or services. • MR = (change in TR)/(change in Q) Gottheil - Principles of Economics, 4e

  21. The MR = MC Rule If TR rises by $10 when output rises by one unit, what is MR? • MR = $10/1 = $10. Gottheil - Principles of Economics, 4e

  22. EXHIBIT 2A TOTAL AND MARGINAL REVENUE CURVES DERIVED FROM SELLING FISH WHEN P = $0.90 Gottheil - Principles of Economics, 4e

  23. EXHIBIT 2B TOTAL AND MARGINAL REVENUE CURVES DERIVED FROM SELLING FISH WHEN P = $0.90

  24. EXHIBIT 2C TOTAL AND MARGINAL REVENUE CURVES DERIVED FROM SELLING FISH WHEN P = $0.90

  25. Exhibit 2: Total and Marginal Revenue Curves Derived from Selling Fish When P = $0.90 1. Why is marginal revenue equal to price in Exhibit 2? • TR = P × Q. Since MR = (change in TR)/(change in Q), then when Q increases by one unit, TR increases by an amount equal to price. Gottheil - Principles of Economics, 4e

  26. Exhibit 2: Total and Marginal Revenue Curves Derived from Selling Fish When P = $0.90 1. Why is marginal revenue equal to price in Exhibit 2? • For example, if quantity increases from 2 to 3, and if price is $0.90, then the change in TR is $(2.70 - 1.80) = $0.90. The change in Q is 1. Therefore, MR = $0.90/1 = $0.90. Gottheil - Principles of Economics, 4e

  27. Exhibit 2: Total and Marginal Revenue Curves Derived from Selling Fish When P = $0.90 1. Why is marginal revenue equal to price in Exhibit 2? • As a result, MR = price. The marginal revenue curve is a horizontal line at the prevailing price. Gottheil - Principles of Economics, 4e

  28. Exhibit 2: Total and Marginal Revenue Curves Derived from Selling Fish When P = $0.90 2. Why is the TR curve in panel a an upward-sloping straight line? • The TR curve is upward-sloping because as output increases, TR increases, since TR = P × Q. Gottheil - Principles of Economics, 4e

  29. Exhibit 2: Total and Marginal Revenue Curves Derived from Selling Fish When P = $0.90 2. Why is the TR curve in panel a an upward-sloping straight line? • The TR curve is a straight line because its slope is equal to price, which does not change. Gottheil - Principles of Economics, 4e

  30. Exhibit 2: Total and Marginal Revenue Curves Derived from Selling Fish When P = $0.90 3. What is the difference between TR and TR′ at an output level of 11,000? • TR at a quantity of 11,000 is $9,900. Gottheil - Principles of Economics, 4e

  31. Exhibit 2: Total and Marginal Revenue Curves Derived from Selling Fish When P = $0.90 3. What is the difference between TR and TR′ at an output level of 11,000? • TR′ at a quantity of 11,000 is $5,500. Gottheil - Principles of Economics, 4e

  32. Exhibit 2: Total and Marginal Revenue Curves Derived from Selling Fish When P = $0.90 3. What is the difference between TR and TR′ at an output level of 11,000? • (TR - TR′) = $4,400. Gottheil - Principles of Economics, 4e

  33. Applying the MR = MC Rule MR = MC rule • The guideline used by a firm to achieve profit maximization. Gottheil - Principles of Economics, 4e

  34. Applying the MR = MC Rule The profit maximization guideline is to keep adding to production as long as the marginal revenue gained from adding production is greater than the marginal cost incurred from adding it. • When MR > MC, increase production. Gottheil - Principles of Economics, 4e

  35. EXHIBIT 3 KEY DATA ON PROFIT MAXIMIZATION Gottheil - Principles of Economics, 4e

  36. Exhibit 3: Key Data on Profit Maximization 1. If quantity is 6,000 in Exhibit 3, what should a firm do? • Increase quantity • Keep quantity the same • Reduce quantity Gottheil - Principles of Economics, 4e

  37. Exhibit 3: Key Data on Profit Maximization 1. If quantity is 6,000 in Exhibit 3, what should a firm do? • Increase quantity • Keep quantity the same • Reduce quantity Gottheil - Principles of Economics, 4e

  38. Exhibit 3: Key Data on Profit Maximization 2. If quantity is 14,000 in Exhibit 3, what should a firm do? • Increase quantity • Keep quantity the same • Reduce quantity Gottheil - Principles of Economics, 4e

  39. Exhibit 3: Key Data on Profit Maximization 2. If quantity is 14,000 in Exhibit 3, what should a firm do? • Increase quantity • Keep quantity the same • Reduce quantity Gottheil - Principles of Economics, 4e

  40. EXHIBIT 4 APPLYING THE MR = MC RULE Gottheil - Principles of Economics, 4e

  41. Exhibit 4: Applying the MR = MC Rule If quantity is 13,000 in Exhibit 4, is profit maximized? • No. Since the MC curve is above MR curve, profit is smaller at 13,000 than if output is set at 10,000. Gottheil - Principles of Economics, 4e

  42. Maximizing Profit on Israel’s Kibbutzim According to Professors Levhari and Barkai, does a kibbutz behave as if it were a profit-maximizing firm? • Yes. While the trademark of the kibbutz is universal equality, this goal does not interfere with maximizing profit from the kibbutz’s agricultural and manufacturing activities. Gottheil - Principles of Economics, 4e

  43. Maximizing Profit on Israel’s Kibbutzim According to Professors Levhari and Barkai, does a kibbutz behave as if it were a profit-maximizing firm? • Evidence for profit-maximizing behavior includes a kibbutz switching from one crop to another based on relative prices. Gottheil - Principles of Economics, 4e

  44. Determining Maximum Profit The formula for determining maximum profit is: • (P - ATC) × Qmax. • Note that Qmax is the profit-maximizing output level. Gottheil - Principles of Economics, 4e

  45. EXHIBIT 5 MEASURING PROFIT MAXIMIZATION Gottheil - Principles of Economics, 4e

  46. Exhibit 5: Measuring Profit Maximization Using the information in Exhibit 5, what is total profit when output is 10,000, price is $0.90, and ATC is $0.645? • Profit is $2,550. Gottheil - Principles of Economics, 4e

  47. Exhibit 5: Measuring Profit Maximization Using the information in Exhibit 5, what is total profit when output is 10,000, price is $0.90, and ATC is $0.645? • $2,550 = $(0.90-0.645) × 10,000. Gottheil - Principles of Economics, 4e

  48. Exhibit 5: Measuring Profit Maximization Using the information in Exhibit 5, what is total profit when output is 10,000, price is $0.90, and ATC is $0.645? • Total profit of $2,550 is represented graphically as the area of the shaded rectangle in Exhibit 5. Gottheil - Principles of Economics, 4e

  49. Maximizing Profit and Minimizing Loss Loss minimization • Faced with the certainty of incurring losses, the firm’s goal is to incur the lowest loss possible from its production and sale of goods and services. Gottheil - Principles of Economics, 4e

  50. Maximizing Profit and Minimizing Loss If price is less than ATC, but greater than AVC, the firm is better off to produce where MR = MC in the short run, even though profit is negative. Gottheil - Principles of Economics, 4e

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