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Background
to Supply
Background to Supply
The Short-run Theory
of Production
SHORT-RUN THEORY OF PRODUCTION
• Profits and the aims of the firm
• Long-run and short-run production:
– fixed and variable factors
• The law of diminishing returns
• The short-run production function:
– total physical product (TPP)
– average physical product (APP)
APP = TPP/QV
– marginal physical product (MPP)
MPP = TPP/QV
Wheat production per year from a particular farm (tonnes)
(a)
Number of
Workers (Lb)
TPP
APP
(=TPP/Lb)
0
0
-
MPP
(= TPP/ Lb)
3
1
3
3
7
2
10
5
(b)
14
3
24
8
12
(c)
4
36
9
4
5
40
8
2
6
42
7
(d)
0
7
42
6
-2
8
40
5
Wheat production per year from a particular farm (tonnes)
(a)
Number of
Workers (Lb)
TPP
APP
(=TPP/Lb)
0
0
-
MPP
(= TPP/ Lb)
3
1
3
3
7
2
10
5
(b)
14
3
24
8
12
(c)
4
36
9
4
5
40
8
2
6
42
7
(d)
0
7
42
6
-2
8
40
5
Wheat production per year from a particular farm (tonnes)
(a)
Number of
Workers (Lb)
TPP
APP
(=TPP/Lb)
0
0
-
MPP
(= TPP/ Lb)
3
1
3
3
7
2
10
5
(b)
14
3
24
8
12
(c)
4
36
9
4
5
40
8
2
6
42
7
(d)
0
7
42
6
-2
8
40
5
Wheat production per year from a particular farm (tonnes)
(a)
Number of
Workers (Lb)
TPP
APP
(=TPP/Lb)
0
0
-
MPP
(= TPP/ Lb)
3
1
3
3
7
2
10
5
(b)
14
3
24
8
12
(c)
4
36
9
4
5
40
8
2
6
42
7
(d)
0
7
42
6
-2
8
40
5
SHORT-RUN THEORY OF PRODUCTION
• Profits and the aims of the firm
• Long-run and short-run production:
– fixed and variable factors
• The law of diminishing returns
• The short-run production function:
– total physical product (TPP)
– average physical product (APP)
APP = TPP/QV
– marginal physical product (MPP)
MPP = TPP/QV
– graphical relationship between TPP, APP and MPP
Wheat production per year from a particular farm
Number of
workers
0
1
2
3
4
5
6
7
8
Tonnes of wheat produced per year
40
30
20
TPP
0
3
10
24
36
40
42
42
40
10
0
0
1
2
3
4
5
Number of farm workers
6
7
8
Wheat production per year from a particular farm
Number of
workers
0
1
2
3
4
5
6
7
8
Tonnes of wheat produced per year
40
30
20
TPP
0
3
10
24
36
40
42
42
40
10
0
0
1
2
3
4
5
Number of farm workers
6
7
8
Wheat production per year from a particular farm
d
Tonnes of wheat produced per year
40
TPP
Maximum output
30
Diminishing returns
set in here
20
b
10
0
0
1
2
3
4
5
Number of farm workers
6
7
8
Tonnes of wheat per year
Wheat production per year from a particular farm
40
TPP
30
20
10
TPP = 7
0
Tonnes of wheat per year
6
7
8
Number of
farm workers (L)
6
7
8
Number of
farm workers (L)
0
1
2
3
4
5
L = 1
14
12
10
8
MPP = TPP / L = 7
6
4
2
0
-2
0
1
2
3
4
5
Tonnes of wheat per year
Tonnes of wheat per year
Wheat production per year from a particular farm
40
TPP
30
20
10
0
1
2
3
4
5
6
7
8
Number of
farm workers (L)
0
1
2
3
4
5
6
7
8
Number of
farm workers (L)
0
14
12
10
8
6
4
2
0
-2
MPP
Tonnes of wheat per year
Wheat production per year from a particular farm
40
TPP
30
20
10
0
Tonnes of wheat per year
0
1
2
3
4
5
6
7
8
Number of
farm workers (L)
14
APP = TPP / L
12
10
8
6
4
APP
2
0
-2
0
1
2
3
4
5
6
7
8
MPP
Number of
farm workers (L)
Tonnes of wheat per year
Wheat production per year from a particular farm
40
TPP
30
b
20
Diminishing returns
set in here
10
0
Tonnes of wheat per year
0
1
2
3
4
5
6
7
8
Number of
farm workers (L)
b
14
12
10
8
6
4
APP
2
0
-2
0
1
2
3
4
5
6
7
8
MPP
Number of
farm workers (L)
Wheat production per year from a particular farm
Tonnes of wheat per year
d
40
TPP
30
20
10
0
0
Tonnes of wheat per year
Maximum
output
b
1
2
3
4
5
6
7
8
Number of
farm workers (L)
b
14
12
10
8
6
4
APP
2
d
0
-2
0
1
2
3
4
5
6
7
8
MPP
Number of
farm workers (L)
Wheat production per year from a particular farm
Tonnes of wheat per year
d
40
Slope = TPP / L
= APP
TPP
30
20
b
10
0
0
Tonnes of wheat per year
c
1
2
3
4
5
6
7
8
Number of
farm workers (L)
b
14
12
10
c
8
6
4
APP
2
d
0
-2
0
1
2
3
4
5
6
7
8
MPP
Number of
farm workers (L)
Background to Supply
Short-run Costs
SHORT-RUN COSTS
• Measuring costs of production:
opportunity costs
– explicit costs
– implicit costs
• Fixed costs and variable costs
• Total costs
– total fixed cost (TFC)
– total variable cost (TVC)
– total cost (TC = TFC + TVC)
Total costs for firm X
Output TFC
(Q)
(£)
100
0
1
2
3
4
5
6
7
80
60
12
12
12
12
12
12
12
12
40
20
0
0
1
2
3
4
5
6
7
8
Total costs for firm X
Output TFC
(Q)
(£)
100
0
1
2
3
4
5
6
7
80
60
12
12
12
12
12
12
12
12
40
20
TFC
0
0
1
2
3
4
5
6
7
8
Total costs for firm X
Output TFC TVC
(Q)
(£)
(£)
100
0
1
2
3
4
5
6
7
80
60
0
10
16
21
28
40
60
91
12
12
12
12
12
12
12
12
40
20
TFC
0
0
1
2
3
4
5
6
7
8
Total costs for firm X
Output TFC TVC
(Q)
(£)
(£)
100
0
1
2
3
4
5
6
7
80
60
0
10
16
21
28
40
60
91
12
12
12
12
12
12
12
12
TVC
40
20
TFC
0
0
1
2
3
4
5
6
7
8
Output TFC TVC
(Q)
(£)
(£)
100
0
1
2
3
4
5
6
7
80
60
TC
(£)
0
10
16
21
28
40
60
91
12
12
12
12
12
12
12
12
Total costs for firm X
12
22
28
33
40
52
72
103
TVC
40
20
TFC
0
0
1
2
3
4
5
6
7
8
Output TFC TVC
(Q)
(£)
(£)
100
0
1
2
3
4
5
6
7
80
60
TC
(£)
0
10
16
21
28
40
60
91
12
12
12
12
12
12
12
12
Total costs for firm X
TC
12
22
28
33
40
52
72
103
TVC
40
20
TFC
0
0
1
2
3
4
5
6
7
8
Total costs for firm X
TC
100
TVC
80
Diminishing marginal
returns set in here
60
40
20
TFC
0
0
1
2
3
4
5
6
7
8
SHORT-RUN COSTS
• Marginal cost
– marginal cost (MC) and the law of
diminishing returns
Average and marginal physical product
Output
b
Diminishing returns
set in here
MPP
Quantity of the variable factor
Average and marginal physical product
b
Output
c
APP
MPP
Quantity of the variable factor
Marginal cost
Costs (£)
MC
Diminishing marginal
returns set in here
x
Output (Q)
SHORT-RUN COSTS
• Marginal cost
– marginal cost (MC) and the law of
diminishing returns
– the relationship between the marginal and
total cost curves
Total costs for firm X
TC
100
TVC
80
Bottom of
the MC curve
60
40
20
TFC
0
0
1
2
3
4
5
6
7
8
SHORT-RUN COSTS
• Marginal cost
– marginal cost (MC) and the law of
diminishing returns
– the relationship between the marginal and
total cost curves
• Average cost
SHORT-RUN COSTS
• Marginal cost
– marginal cost (MC) and the law of
diminishing returns
– the relationship between the marginal and
total cost curves
• Average cost
– average fixed cost (AFC)
SHORT-RUN COSTS
• Marginal cost
– marginal cost (MC) and the law of
diminishing returns
– the relationship between the marginal and
total cost curves
• Average cost
– average fixed cost (AFC)
– average variable cost (AVC)
SHORT-RUN COSTS
• Marginal cost
– marginal cost (MC) and the law of
diminishing returns
– the relationship between the marginal and
total cost curves
• Average cost
– average fixed cost (AFC)
– average variable cost (AVC)
– average (total) cost (AC)
SHORT-RUN COSTS
• Marginal cost
– marginal cost (MC) and the law of
diminishing returns
– the relationship between the marginal and
total cost curves
• Average cost
– average fixed cost (AFC)
– average variable cost (AVC)
– average (total) cost (AC)
– relationship between AC and MC
Average and marginal costs
MC
AC
Costs (£)
AVC
z
y
x
AFC
Output (Q)
Background to Supply
The Long-run Theory
of Production
LONG-RUN THEORY OF PRODUCTION
• All factors variable in long run
• The scale of production:
– constant returns to scale
– increasing returns to scale
– decreasing returns to scale
Short-run and long-run increases in output
Short run
Long run
Input 1
Input 2
Output
Input 1
Input 2
Output
3
1
25
1
1
15
3
2
45
2
2
35
3
3
60
3
3
60
3
4
70
4
4
90
3
5
75
5
5
125
LONG-RUN THEORY OF PRODUCTION
• Economies of scale
– specialisation & division of labour
– indivisibilities
– container principle
– greater efficiency of large machines
– by-products
– multi-stage production
– organisational & administrative economies
– financial economies
– economies of scope
LONG-RUN THEORY OF PRODUCTION
• Diseconomies of scale
• External economies and diseconomies
of scale
• Optimum combination of factors
MPPa/Pa = MPPb/Pb ... = MPPn/Pn
Background to Supply
Isoquant–Isocost
Analysis
ISOQUANT- ISOCOST ANALYSIS
• Isoquants
– their shape
An isoquant
45
40
Units
of K
40
20
10
6
4
Units of capital (K)
35
30
25
Units
of L
5
12
20
30
50
Point on
diagram
a
b
c
d
e
20
15
10
5
0
0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
An isoquant
45
a
40
Units
of K
40
20
10
6
4
Units of capital (K)
35
30
25
Units
of L
5
12
20
30
50
Point on
diagram
a
b
c
d
e
20
15
10
5
0
0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
An isoquant
45
a
40
Units
of K
40
20
10
6
4
Units of capital (K)
35
30
25
Units
of L
5
12
20
30
50
Point on
diagram
a
b
c
d
e
b
20
15
10
5
0
0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
An isoquant
45
a
40
Units
of K
40
20
10
6
4
Units of capital (K)
35
30
25
Units
of L
5
12
20
30
50
Point on
diagram
a
b
c
d
e
b
20
15
c
10
d
e
5
0
0
5
10
15
20
25
30
Units of labour (L)
35
40
45
50
ISOQUANT- ISOCOST ANALYSIS
• Isoquants
– their shape
– diminishing marginal rate of substitution
Diminishing marginal rate of factor substitution
14
g
Units of capital (K)
12
K = 2
MRS = K / L
MRS = 2
h
10
L = 1
8
6
4
2
isoquant
0
0
2
4
6
8
10
12
14
Units of labour (L)
16
18
20
22
Diminishing marginal rate of factor substitution
14
g
Units of capital (K)
12
K = 2
MRS = K / L
MRS = 2
h
10
L = 1
8
j
MRS = 1
k
K = 1
6
L = 1
4
2
isoquant
0
0
2
4
6
8
10
12
Units of labour (L)
14
16
18
20
ISOQUANT- ISOCOST ANALYSIS
• Isoquants
– their shape
– diminishing marginal rate of substitution
– an isoquant map
An isoquant map
Units of capital (K)
30
20
10
I5
I4
I1
0
0
10
Units of labour (L)
I2
20
I3
ISOQUANT- ISOCOST ANALYSIS
• Isoquants
– their shape
– diminishing marginal rate of substitution
– isoquants and returns to scale
An isoquant map
Units of capital (K)
30
20
10
I5
I4
I1
0
0
10
Units of labour (L)
I2
20
I3
ISOQUANT- ISOCOST ANALYSIS
• Isoquants
– their shape
– diminishing marginal rate of substitution
– isoquants and returns to scale
– isoquants and marginal returns
Diminishing marginal rate of factor substitution
14
g
Units of capital (K)
12
K = 2
MRS = K / L
MRS = 2
h
10
L = 1
8
j
MRS = 1
k
K = 1
6
L = 1
4
2
isoquant
0
0
2
4
6
8
10
12
Units of labour (L)
14
16
18
20
ISOQUANT- ISOCOST ANALYSIS
• Isoquants
– their shape
– diminishing marginal rate of substitution
– isoquants and returns to scale
– isoquants and marginal returns
• Isocosts
ISOQUANT- ISOCOST ANALYSIS
• Isoquants
– their shape
– diminishing marginal rate of substitution
– isoquants and returns to scale
– isoquants and marginal returns
• Isocosts
– slope and position of the isocost
An isocost
30
Assumptions
Units of capital (K)
25
PK = £20 000
W = £10 000
TC = £300 000
20
15
10
5
0
0
5
10
15
20
25
Units of labour (L)
30
35
40
An isocost
30
Assumptions
Units of capital (K)
25
PK = £20 000
W = £10 000
TC = £300 000
20
a
15
b
10
c
5
TC = £300 000
d
0
0
5
10
15
20
25
Units of labour (L)
30
35
40
ISOQUANT- ISOCOST ANALYSIS
• Isoquants
– their shape
– diminishing marginal rate of substitution
– isoquants and returns to scale
– isoquants and marginal returns
• Isocosts
– slope and position of the isocost
– shifts in the isocost
ISOQUANT- ISOCOST ANALYSIS
• Least-cost combination of factors for a
given output
– point of tangency
Finding the least-cost method of production
35
Assumptions
Units of capital (K)
30
PK = £20 000
W = £10 000
25
TC = £200 000
20
TC = £300 000
15
TC = £400 000
10
TC = £500 000
5
0
0
10
20
30
Units of labour (L)
40
50
Finding the least-cost method of production
35
Units of capital (K)
30
25
s
TC = £500 000
20
15
TC = £400 000
r
10
t
5
TPP1
0
0
10
20
30
Units of labour (L)
40
50
ISOQUANT- ISOCOST ANALYSIS
• Least-cost combination of factors for a
given output
– point of tangency
– comparison with marginal productivity
approach
ISOQUANT- ISOCOST ANALYSIS
• Least-cost combination of factors for a
given output
– point of tangency
– comparison with marginal productivity
approach
• Highest output for a given cost of
production
Units of capital (K)
Finding the maximum output for a given total cost
TPP5
TPP4
TPP3
TPP2
TPP1
O
Units of labour (L)
Units of capital (K)
Finding the maximum output for a given total cost
Isocost
TPP5
TPP4
TPP3
TPP2
TPP1
O
Units of labour (L)
Finding the maximum output for a given total cost
r
Units of capital (K)
s
u
v
TPP5
TPP4
TPP3
TPP2
TPP1
O
Units of labour (L)
Finding the maximum output for a given total cost
r
Units of capital (K)
s
K1
t
u
v
TPP5
TPP4
TPP3
TPP2
TPP1
O
L1
Units of labour (L)
Background to Supply
Long-run Costs
LONG-RUN COSTS
• Long-run average costs
– shape of the LRAC curve
– assumptions behind the curve
Costs
Alternative long-run average cost curves
Economies of Scale
LRAC
O
Output
Alternative long-run average cost curves
LRAC
Costs
Diseconomies of Scale
O
Output
Alternative long-run average cost curves
Costs
Constant costs
O
LRAC
Output
A typical long-run average cost curve
Costs
LRAC
O
Output
Costs
A typical long-run average cost curve
O
Economies
of scale
Constant
costs
Output
Diseconomies
of scale
LRAC
LONG-RUN COSTS
• Long-run average costs
– shape of the LRAC curve
– assumptions behind the curve
• Long-run marginal costs
Costs
Long-run average and marginal costs
Economies of Scale
LRAC
LRMC
O
Output
Long-run average and marginal costs
LRMC
Costs
Diseconomies of Scale
O
Output
LRAC
Long-run average and marginal costs
Costs
Constant costs
O
LRAC = LRMC
Output
Long-run average and marginal costs
Initial economies of scale,
then diseconomies of scale
LRAC
Costs
O
LRMC
Output
LONG-RUN COSTS
• Long-run average costs
– shape of the LRAC curve
– assumptions behind the curve
• Long-run marginal costs
• Relationship between long-run and
short-run average costs
LONG-RUN COSTS
• Long-run average costs
– shape of the LRAC curve
– assumptions behind the curve
• Long-run marginal costs
• Relationship between long-run and
short-run average costs
– the envelope curve
Deriving long-run average cost curves: factories of fixed size
Costs
SRAC1 SRAC
2
SRAC3
1 factory
2 factories
3 factories4 factories
O
Output
SRAC5
SRAC4
5 factories
Deriving long-run average cost curves: factories of fixed size
SRAC1 SRAC
2
SRAC3
SRAC5
SRAC4
Costs
LRAC
O
Output
Costs
Deriving a long-run average cost curve: choice of factory size
Examples of short-run
average cost curves
O
Output
Deriving a long-run average cost curve: choice of factory size
Costs
LRAC
O
Output
LONG-RUN COSTS
• Long-run average costs
– shape of the LRAC curve
– assumptions behind the curve
• Long-run marginal costs
• Relationship between long-run and
short-run average costs
– the envelope curve
• Long-run cost curves in practice
LONG-RUN COSTS
• Long-run average costs
– shape of the LRAC curve
– assumptions behind the curve
• Long-run marginal costs
• Relationship between long-run and
short-run average costs
– the envelope curve
• Long-run cost curves in practice
– the evidence
LONG-RUN COSTS
• Long-run average costs
– shape of the LRAC curve
– assumptions behind the curve
• Long-run marginal costs
• Relationship between long-run and
short-run average costs
– the envelope curve
• Long-run cost curves in practice
– the evidence
– minimum efficient plant size
LONG-RUN COSTS
• Derivation of long-run costs from an
isoquant map
– derivation of long-run costs
Units of capital (K)
Deriving an LRAC curve from an isoquant map
At an output of 200
LRAC = TC2 / 200
100 200
O
Units of labour (L)
Deriving an LRAC curve from an isoquant map
Units of capital (K)
Note: increasing returns
to scale up to 400 units;
decreasing returns to
scale above 400 units
700
100 200
O
Units of labour (L)
600
500
400
300
LONG-RUN COSTS
• Derivation of long-run costs from an
isoquant map
– derivation of long-run costs
– the expansion path
Units of capital (K)
Deriving an LRAC curve from an isoquant map
Expansion path
700
100 200
O
Units of labour (L)
600
500
400
300
Background to Supply
Revenue
REVENUE
• Defining total, average and marginal
revenue
• Revenue curves when firms are price
takers (horizontal demand curve)
– average revenue (AR)
– marginal revenue (MR)
S
AR, MR (£)
Price (£)
Deriving a firm’s AR and MR: price-taking firm
Pe
D
O
Q (millions)
(a) The market
O
Q (hundreds)
(b) The firm
S
AR, MR (£)
Price (£)
Deriving a firm’s AR and MR: price-taking firm
D = AR
= MR
Pe
D
O
Q (millions)
(a) The market
O
Q (hundreds)
(b) The firm
REVENUE
• Defining total, average and marginal
revenue
• Revenue curves when firms are price
takers (horizontal demand curve)
– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
Total revenue for a price-taking firm
Quantity Price = AR
(units) = MR (£)
6000
0
200
400
600
800
1000
1200
TR (£)
5000
4000
3000
5
5
5
5
5
5
5
2000
1000
0
0
200
400
600
Quantity
800
1000
1200
Total revenue for a price-taking firm
Quantity Price = AR
(units) = MR (£)
6000
0
200
400
600
800
1000
1200
TR (£)
5000
4000
3000
5
5
5
5
5
5
5
TR
(£)
0
1000
2000
3000
4000
5000
6000
2000
1000
0
0
200
400
600
Quantity
800
1000
1200
Total revenue for a price-taking firm
Quantity Price = AR
(units) = MR (£)
6000
0
200
400
600
800
1000
1200
TR (£)
5000
4000
3000
5
5
5
5
5
5
5
TR
TR
(£)
0
1000
2000
3000
4000
5000
6000
2000
1000
0
0
200
400
600
Quantity
800
1000
1200
Total revenue for a price-taking firm
TR
6000
TR (£)
5000
4000
3000
2000
1000
0
0
200
400
600
Quantity
800
1000
1200
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand
curve)
– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
Revenues for a firm facing a
downward-sloping demand curve
Q
(units)
P = AR
(£)
1
8
TR
(£)
MR
(£)
8
6
2
7
14
4
3
6
18
2
4
5
20
0
5
4
20
–2
6
3
18
–4
7
2
14
Revenues for a firm facing a
downward-sloping demand curve
Q
(units)
P = AR
(£)
1
8
TR
(£)
MR
(£)
8
6
2
7
14
4
3
6
18
2
4
5
20
0
5
4
20
–2
6
3
18
–4
7
2
14
Revenues for a firm facing a
downward-sloping demand curve
Q
(units)
P = AR
(£)
1
8
TR
(£)
MR
(£)
8
6
2
7
14
4
3
6
18
2
4
5
20
0
5
4
20
–2
6
3
18
–4
7
2
14
AR and MR curves for a firm facing a downward-sloping D curve
Q P =AR
(units) (£)
8
1
7
2
6
3
5
4
4
5
3
6
2
7
8
AR, MR (£)
6
4
2
AR
0
1
-2
-4
2
3
4
5
6
7
Quantity
AR and MR curves for a firm facing a downward-sloping D curve
Q P =AR
(units) (£)
8
1
7
2
6
3
5
4
4
5
3
6
2
7
8
AR, MR (£)
6
4
2
TR MR
(£) (£)
8
6
14
4
18
2
20
0
20
-2
18
-4
14
AR
0
1
2
3
4
5
6
7
-2
-4
MR
Quantity
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand
curve)
– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
TR curve for a firm facing a downward-sloping D curve
20
16
Quantity P = AR
(units)
(£)
TR (£)
12
1
2
3
4
5
6
7
8
4
TR
(£)
8
7
6
5
4
3
2
8
14
18
20
20
18
14
5
6
0
0
1
2
3
4
Quantity
7
TR curve for a firm facing a downward-sloping D curve
20
16
Quantity P = AR
(units)
(£)
TR (£)
12
1
2
3
4
5
6
7
8
4
TR
TR
(£)
8
7
6
5
4
3
2
8
14
18
20
20
18
14
5
6
0
0
1
2
3
4
Quantity
7
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand
curve)
– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
– revenue curves and price elasticity of
demand
TR curve for a firm facing a downward-sloping D curve
Elasticity = -1
20
16
TR
TR (£)
12
8
4
0
0
1
2
3
4
Quantity
5
6
7
AR and MR curves for a firm facing a downward-sloping D curve
8
Elastic
Elasticity = -1
AR, MR (£)
6
4
Inelastic
2
AR
0
1
2
3
4
5
6
7
-2
-4
MR
Quantity
REVENUE
• Revenue curves when price varies with
output (downward-sloping demand
curve)
– average revenue (AR)
– marginal revenue (MR)
– total revenue (TR)
– revenue curves and price elasticity of
demand
• Shifts in revenue curves
Background to Supply
Profit
Maximisation
PROFIT MAXIMISATION
• Using total curves
– maximising difference between TR and TC
Finding maximum profit using total curves
24
TR, TC, TP (£)
20
16
12
8
4
0
1
-4
-8
2
3
4
5
6
7
Quantity
Finding maximum profit using total curves
24
TR, TC, TP (£)
20
16
TR
12
8
4
0
1
-4
-8
2
3
4
5
6
7
Quantity
Finding maximum profit using total curves
TC
24
TR, TC, TP (£)
20
16
TR
12
8
4
0
1
-4
-8
2
3
4
5
6
7
Quantity
PROFIT MAXIMISATION
• Using total curves
– maximising difference between TR and TC
– the total profit curve
Finding maximum profit using total curves
TC
24
TR, TC, TP (£)
20
16
TR
12
8
4
0
1
2
3
4
5
6
-4
-8
TP
7
Quantity
Finding maximum profit using total curves
TC
24
b
TR, TC, TP (£)
20
16
TR
a
12
8
4
c
0
1
d
2
3
4
5
6
-4
-8
TP
7
Quantity
TR, TC, TP (£)
Finding maximum profit using total curves
24
22
20
18
16
14
12
10
8
6
4
2
0
-2
-4
-6
-8
TC
d
TR
e
f
1
2
3
4
5
6
TP
7
Quantity
PROFIT MAXIMISATION
• Using total curves
– maximising difference between TR and TC
– the total profit curve
• Using marginal and average curves
PROFIT MAXIMISATION
• Using total curves
– maximising difference between TR and TC
– the total profit curve
• Using marginal and average curves
– stage 1:
profit maximised where MR = MC
Finding the profit-maximising output using marginal curves
16
Costs and revenue (£)
12
8
4
0
1
-4
2
3
4
5
6
7
Quantity
Finding the profit-maximising output using marginal curves
16
MC
Costs and revenue (£)
12
8
4
0
1
-4
2
3
4
5
6
7
Quantity
Finding the profit-maximising output using marginal curves
16
MC
Costs and revenue (£)
12
8
4
Profit-maximising
output
e
0
1
-4
2
3
4
5
6
7
MR
Quantity
PROFIT MAXIMISATION
• Using total curves
– maximising difference between TR and TC
– the total profit curve
• Using marginal and average curves
– stage 1:
profit maximised where MR = MC
– stage 2:
using AR and AC curves to measure maximum
profit
Measuring the maximum profit using average curves
16
MC
Costs and revenue (£)
12
8
4
0
1
-4
2
3
4
5
6
7
MR
Quantity
Measuring the maximum profit using average curves
16
MC
Costs and revenue (£)
12
8
4
AR
0
1
-4
2
3
4
5
6
7
MR
Quantity
Measuring the maximum profit using average curves
16
MC
Total profit =
£1.50 x 3 = £4.50
Costs and revenue (£)
12
AC
8
a
6.00
TOTAL PROFIT b
4.50
4
AR
0
1
-4
2
3
4
5
6
7
MR
Quantity
PROFIT MAXIMISATION
• Some qualifications
– long-run profit maximisation
– the meaning of profit
• What if a loss is made?
– loss minimising:
still produce where MR = MC
Loss-minimising output
MC
Costs and revenue (£)
AC
AC
LOSS
AR
AR
O
Q
MR
Quantity
PROFIT MAXIMISATION
• Some qualifications
– long-run profit maximisation
– the meaning of profit
• What if a loss is made?
– loss minimising:
still produce where MR = MC
– short-run shut-down point:
P = AVC
Costs and revenue (£)
The short-run shut-down point
AC
AVC
P=
AVC
AR
O
Q
Quantity
PROFIT MAXIMISATION
• Some qualifications
– long-run profit maximisation
– the meaning of profit
• What if a loss is made?
– loss minimising:
still produce where MR = MC
– short-run shut-down point:
P = AVC
– long-run shut-down point:
P = LRAC