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Business Economics
The Behavior of Firms
Assumption: Profit Maximization
Problem: You have 6 acres of land and you are deciding
how many acres to spray with insecticide-Variable costs
but no fixed cost
Acres
Total Total
Sprayed Benefit Cost
0
0
0
Net
Gain
0
1
6
3
3
Marginal
Benefit
6
Marginal
Cost
3
2
11
6
5
5
3
3
4
5
6
15
18
20
21
9
12
15
18
6
6
5
3
4
3
2
1
3
3
3
3
Profit Maximization
25
Total
Benefits
20
18
11
10
21
18
15 6
15
$
15
20
12
6
Total Cost
9
6
5
6
3
0
0
0
1
2
3
Acres
4
5
6
Profit Maximization
7
6
Marginal
Benefit
$ per Acre
5
4
3
Marginal
Cost
2
1
0
1
2
3
4
Acres
5
6
Profit Maximization
Total Benefit=5+10ln(acre)
Marginal Benefit=10/acre
Total Cost=3(acre)
Marginal cost=3
Marginal Benefit=Marginal Cost
10/acres=3
acres=10/3
Net Gain=Total Benefit-Total Cost
Choose acre to:
Max{Net Gain}=Max{5+10ln(acre)-3(acre)}
First Order Condition (10/acre)-3=0
Second Order Condition -10/(acre^2)<0
Maximizing Profits
30
Total
Benefits
20
Max
10
Net Gain
0
0
$
Total Costs
1
2
3
-10
-20
-30
-40
-50
Acres
4
5
6
Maximizing Profits
11
10
Marginal
Benefits=
10/acres
9
8
$
7
6
5
Marginal
Costs=3
4
3
2
1
0
0
2
4
Acres
6
8
Profit Maximization
Fix Cost of $4
Acres
Total Total
Sprayed Benefit Cost
0
0
4
Net
Gain
-4
1
6
7
-1
2
3
4
5
6
11
15
18
20
21
10
13
16
19
22
1
2
2
1
-1
Marginal
Benefit
6
Marginal
Cost
3
5
4
3
2
1
3
3
3
3
3
Profit Maximization
25
20
18
16
15
13
$
15
20
19
22
21
11
10
10
7
6
5
4
0
0
0
1
2
3
Acres
4
5
6
Profit Maximization
7
$ per (last) Acre
6
Marginal
Benefit
5
4
3
Marginal
Cost
2
1
0
1
2
3
4
Acres
5
6
Profit Maximization
Fix cost of $10
Acres
Total Total
Sprayed Benefit Cost
0
0
10
Net
Gain
-10
1
6
13
-7
Marginal
Benefit
6
Marginal
Cost
3
2
3
4
5
6
11
15
18
20
21
16
19
22
25
28
-5
5
3
-4
-4
-5
-7
4
3
2
1
3
3
3
3
Profit Maximization
30
28
25
25
22
$
20
19
16
15
18
21
15
13
10
20
11
10
6
5
0
0
0
1
2
3
Acres
4
5
6
Marginal Rule
If it is worth to produce at all,
then it should be produced up to
the point where marginal costs
are equal to marginal benefits
Revenues
Price
Revenues=
Price X Quantity
$10
9
8
7
6
5
4
3
Quantity
Demanded
Total
Revenue
0
1
2
3
4
5
6
7
8
$10
18
24
28
30
30
28
24
Price
Revenue
Should firms maximize revenues?
D2
P
P’
Q
Q’
Quantity
Profit Maximization
Price Quantity
Total
Marginal
Revenue Revenue
Total
Cost
Marginal
Cost
Profit
1
2
7
13
$10
9
0
1
2
$10
18
10
8
2
3
5
8
7
6
5
3
4
5
6
24
28
30
30
6
4
2
0
8
12
17
23
3
4
5
6
16
16
13
7
4
3
7
8
28
24
-2
-4
30
7
-2
38
8
-14
Change on Fixed Costs
Total Costs $
Total Cost
3
Fixed
Cost 2
Total
Revenue
Total Cost
2
Total Cost
1
Fixed
Cost 1
Q*
Quantity
Change on Variable Costs
Total Costs $
Total Cost
2
Total
Revenue
Total Cost
1
Fixed
Cost
Q**
Q*
Quantity
$ per (last) unit
Marginal Costs and Revenues
Marginal
Cost 2
Marginal
Revenue
Marginal
Cost 1
Q** Q*
Quantity
Fixed Costs & Sunk Costs
We will call fixed costs to costs that do not
change with the level of production and
are avoidable by closing the firm (exit the
market).
Sunk costs are costs that do not change
with the level of production and are not
avoidable by closing the firm.