Chapter 5: Firm theory Nguyen Thi Minh Thu Introduction n  Instructor s name: Nguyen Thi Minh Thu n  Department of Microeconomics, Faculty of International Economics, Foreign Trade University n  Email: thu.nguyentm@gmail.com n  Phone number: 0902172177 ( office hours) DON T n BE LATE n Chat in class n Sleep in class n Use phone Chapter outline 1.  Production function 2.  Production cost 3.  Profit maximazation Production function 1.1 Key definitions -  Production is the process that transforms inputs into outputs, i.e goods and services, to satisfy human wants -  Common types of inputs Capital (K) : machines and building Labour (L) : human services Material (M): raw inputs and processed products Production function n  Production function is a mathematic representation of the relationship between quantities of inputs used and maximum quantity of output that can be produced given the current technology Production function n  Production function with two inputs Q = f (K, L) Where Q: output quantity K: physical capital L: labour Production function n  Short run: The period of time during which at least one input is fixed n  Long run: the period of time which is lengthy enough for all inputs to vary Production function 1.2 Short-run production Assumption: Labour is variable while capital is fixed à  Firm à  can increase output only by using more labour Two questions -  How many products that one labour unit can contribute on average? -  Should the firm hire another labour unit? If so, how many products this labour can contribute? Production function n  Average product of labour, or APL, is the ratio of total output to the numbers of labour unit used Q APL = L Production cost n  Relationship between MC and ATC MC > ATC : ATC é MC < ATC : ATC ê MC = ATC : ATC Production cost MC MC,P ATC ATCmin AVC AVCmin AFC Q Profit maximization n  Total revenue is the amount of money that a firm receive from the sale of its output n  Average revenue can be determined by dividing total revenue by total quantity TR AR = Q Profit maximization n  Marginal revenue is the change in total revenue resulting from the sale of an extra product ΔTR MR = ΔQ Profit maximization n  If the total revenue function is continuous, the we have MR = TR (Q) n  Marginal revenue thus measures the slope of the total revenue curve n  TR max è MR = (E = -1) Profit maximization P P= Q+ è TR = PQ = Q2 + è MR = Q + E = -1 D - / - / MR Q Q Profit maximization n  Total revenue is the integral of marginal revenue Therefore the whole area below the marginal curve yields the value of total revenue Q0 Q0 ∫ MRdQ = TR € = TRQ0 MR Profit maximization §  Profit is the firm s total revenue minus its total cost Profit = Total revenue - Total cost à  Economic profit versus accounting profit §  Economic profit is zero à the firm earns normal profit §  Economic profit is positive à abnormal profit §  Economic profit is negative à loss Profit maximization n  Profit maximization Q* : π = TR – TC max è π (Q) – TC > MC : Increase output n  MR =0 è TR (Q) n  MR (Q) è MR – MC = è MR = MC =0 < MC : Decrease output n  MR = MC : optimal output level PRACTICE n  n  Demand is given by P = 55 - 2Q Cost function is TC = 100 - 5Q + Q2 a.  What is the marginal revenue as a function of Q? b.  If the firm wants to maximize profits, what price does it charge? How much profit and consumer surplus is generated at this price? c.  If the firm wants to maximize total revenue, what price does it charge? Calculate quantity and profit Summary n  The goal of firms is to maximize profit, which equals total revenue minus total cost n  When analyzing a firm s behavior, it is important to include all the opportunity costs of production n  Some opportunity costs are explicit while other opportunity costs are implicit Summary n  A firm s costs reflect its production process n  A typical firm s production function gets flatter as the quantity of input increases, displaying the property of diminishing marginal product n  A firm s total costs are divided between fixed and variable costs Fixed costs not change when the firm alters the quantity of output produced; variable costs change as the firm alters quantity of output produced Summary n  Average total cost is total cost divided by the quantity of output n  Marginal cost is the amount by which total cost would rise if output were increased by one unit n  The marginal cost always rises with the quantity of output n  Average cost first falls as output increases and then rises Summary n  The n  The average-total-cost curve is U-shaped marginal-cost curve always crosses the average-total-cost curve at the minimum of ATC ... class n Sleep in class n Use phone Chapter outline 1.  Production function 2.  Production cost 3.  Profit maximazation Production function 1.1 Key definitions -  Production is the process that transforms... produced given the current technology Production function n  Production function with two inputs Q = f (K, L) Where Q: output quantity K: physical capital L: labour Production function n  Short run:... resulting from the use of an extra unit of labour, given the other production factor (K) held constant ΔQ MPL = ΔL Production function n  If production function is continuous, the we have MPL = Q(L ")