FIRMS AS PROFIT MAXIMIZERS Chapter 7 (pp. 160-73)
Concept applies only to for profit firms in the private sector; thus excluding
all public firms, and all private non-profit firms----public and private
universities, arts organizations, many hospitals, charitable organizations,
religious organizations…..
Otherwise, All firms are assumed to have one dominant goal..making as
much money (PROFIT REALLY) as possible…..How this identical
behavior has differential impact in the market place will be a function of the
particular environment (MARKET STRUCTURE) in which the firm
operates.
1. CONCEPT OF PROFIT
A. THE USUAL (ACCOUNTING PROFIT) Which typically
comes from the firms profit and loss statement….Simply the difference
between gross receipts and expenditures.
These profits are often defined as BEFORE AND AFTER TAXE profits
B. THE UNUSUAL (THE ECONOMIST’S VERSION) WHICH
INCLUDES IMPLICIT (OR OPPORTUNITY) COSTS……….what you
could have done with the time, money and resources that went into the
business in question.
C. WHY PROFITS AT ALL???
Standard text book answerÎ RISK AND INNOVATION
MARXIST NOTION VERY DIFFERENT……Comes solely out of the
ownership function which allows the owner to exploit the worker, that is to
take a portion of the labor effort that rightfully belongs to the worker (while
the risk is reduced via the efforts of government…..in reality pretty hard to
eliminate all risk…question ultimately becomes source of profits….i.e.,
according to Marx, out of the hide of the worker….In this discussion, it is
important not to confuse the entrepreneurial function with the ownership
function—often performed by the same individual. Analytically distinct
however!
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PROFIT MAXIMIZING OUTPUT
1. Discussion is now about ACCOUNTING PROFITS
2. Profits sought are the maximum difference between revenue and cost:
Total Profit = Total Revenue minus Total Cost
Chapter 8 DEFINED COSTS
Thus, need to define revenues, which are simply the number of goods sold
times the price of the good, i.e., the area under the firm’s demand curve.
3. Nature of the FIRM’S demand curve varies depending on market
structutre>>>>Chapters 9, 14, 15 and 16...for the moment, assume a linear,
downward sloping curve, and derive total revenue:
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$
Demand
a
o
b
c output
Total Revenue is a maximum with price (a) at output (b); and is obviously
zero when demand is (o) and a very high (price) and also zero when price is
o and demand is large (c)
$
Total Revenue
o
b
c
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output
4. GRAPHICAL DISCUSSION IN TERMS OF TOTAL COST AND
TOTAL REVENUE…..>>>>>>SAME RESULTS USING MARGINAL
REVENUE AND MARGINAL COST APPROACH WHICH WILL BE
DONE EXPLICITLY IN LECTURES ON CHs 9, 14, 15 and 16.
(STUDENTS SHOULD STUDY MARGINAL APPROACH IN CH 7,
figure 7-3 pages 168ff)
MAIN POINT REGARDING PROFIT MAX>>>WHERE MR = MC,
IMPLIES, LOGICALLY, THAT IF ADDITIONAL SALES BRING IN
MORE THAN THEY COST, FIRM SHOULD PRODUCE>>>>WHERE
THE REVERSE IS THE CASE (MC > MR) FIRM SHOULD NOT
PRODUCE>>>>>>>>>MC = MR IS BLISS (with one important
qualification to be discussed shortly)
$
Total Cost
Total Reveune
o x1
x2
b
x3
c
output
The heavy dashed line represents total profits, which are zero and x1 and x3,
where total costs equal total revenue. Profits are negative before x1 and
after x3 since costs exceed revenues in both areas. Profits are a maximum
at x2, where the vertical distance between TC and TR is a maximum.
And from earlier math, where the slopes of the TC and TR are equal. That
is, where MR = MC
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DON’T CRY OVER SPILT MILK (THE SHUT-DOWN RULE)
1 EXAMPLE OF NICKELODEON RENTAL
ANNUAL NON REFUNDABLE BUT TRANSFERABLE
MEMBERSHIP $104.00
which provides a discount ($4 off of each $6 ticket), and free popcorn, coffee, and other snacks.
YOU PLANNED TO GOT TO A MOVIE A WEEK>>>>FOR A
TOTAL COST OF $208/YEAR, OR $4/FLICK
VISION PROBLEMS FROM EXCESSIVE PRIMAL SCREAMING
MAKES THE PASS WORTHLESS TO YOU….YOU WILL BE
BILLED FOR EVERY MOVIE USED ON YOUR PASS….WHAT
IS THE MINIMUM AMOUNT YOU WOULD TAKE PER MOVIE
TO LET SOMEONE ELSE USE YOUR PASS???
I.E., SO LONG AS VARIABLE COSTS ARE COVERED, FIRM
WILL OPERATE IN THE SHORT RUN!!!
GRAPHICAL ANALYSIS OF THE SHUT DOWN RULE, AND
THE SAME ANALYSIS USING BOTH TOTALS AND
AVERAGES……………………..
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Assume that Nick can sell as many admissions as it wishes at $6. Thus, total
revenue (TR) = $6.00 x (admissions)—a linear relationship. Notice also,
that the Average and Marginal revenue = $6.00
Analysis in Totals
TR
TC
$
admissions
If the decision was based on TC and TR, the Nick would close, since total
costs exceed total revenue from the git go. But this would be an error,
assuming, as the diagram indicates, the existence of fixed costs. If the Nick
can cover at least some of its variable costs, it should stay open for the
year (assuming that the fixed costs expire at the end of the year).
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$
TR
VC
Total Revenue
Admissions
srp
At srp, the firm is covering its variable costs, and then some; thus
contributing to fixed costs, and reducing losses in the short run. The VC
curve is simply a vertical displacement (downward) of the TC curve in the
previous graph.
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THE SAME ANALYSIS USING MARGINAL AND AVERAGES
RATHER THAN TOTALS
The FIRM’S demand curve is simply a horizontal line, at $6. That is, for the
moment (this changes when we get to chapters 14 on), we assume that the
firm can get as many admissions as it wants at a constant price.
$
6
D = AR = MR
admissions
Note: Average Revenue and Marginal Revenue are both the same, $6.
ADDING THE COST CURVES, AVERAGE TOTAL AND VARIABLE,
AND MARGINAL COST
$
MC
6
ATC
D = AR = MR
b
admissions
Losses are incurred where MC = MR, (b) but variable costs may be covered,
as indicated below, at (a).
$
MC
6
ATC
AVC
D = AR = MR
a
b
admissions
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BLANK PAGE BY DESIGN
[aka a “mistake’]
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