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In lessons 7, 8/9, 10, and 11 we will
be looking at the producer decision of HOW MUCH TO PRODUCE.
We will use benefit cost analysis (MB=MC) to find the profit
maximizing quantity or WHAT WE GET. Once we know how much
businesses will produce, we will ask: Is this quantity
efficient (both allocatively and productively)?
To find the profit maximizing
quantity we will use benefit-cost analysis: MB=MC. So, what
are the extra benefits of producing one more unit of output?
How do businesses benefit when they produce one more? Well,
they get more money, called revenue. Even if they are
earning losses, they receive more revenue when they sell
more. The extra revenue that businesses get when they
produce and sell one more unit is their marginal revenue
(MR). This is the MB of producing one more.
But there are also extra costs of
producing one more unit of output. We call these the
marginal costs (MC). When MR=MC (MB=MC) their profits will
be maximized. NOTE: when MR=MC profits are not necessarily
zero, but they are as large as possible. We will calculate
these profits in lessons 8/9, 10, and 11.
In lessons 7a, 7b, and 7c we begin by
looking at the MC. Then in lessons 8/9, 10, and 11 we add
the MR.
In lessons 7a, 7b, and 7c we will
introduce three new sets of graphs. First (lesson 7a) we
will look at the production function thast shows how output
changes when we add more resources. We will then (lesson 7b)
use the production function graph to understand the SHAPES
of the other two sets of graphs. The two sets of cost graphs
show us what happens to costs when we produce more. These
two sets of cost graphs are the total cost graphs (TC, TVC,
and TFC) and the average cost graphs (ATC, AVC, AFC, and
MC).
Let's begin with the production
function, or HOW DOES OUTPUT CHANGE WHEN WE ADD MORE
RESOURCES?
One more thing. If a firm is earning
zero economic profits, that is OK!!! But a zero economic
profit is NOT the same as a zero accounting profit. A zero
economic profit could be an accounting profit of $1 million
dollars a year! Be sure you learn the difference between an
"economic profit" and an "accounting profit" and understand
WHY the difference exists. (Hint: It has to do with the fact
that economists always use "opportunity costs" and
accountants don't.)
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