Lecture 26.pdf

2010: LECTURE 26 1 LECTURE 26: FIRM DECISION-MAKING: COMPETITIVE FIRMS Short-Run Decisions: - presence - output choice short-run for existing firm to be present? price $min AVC how much output? price = MC Mankiw: Chapter 14 2010: LECTURE 26 2 EXISTING FIRM: SHORT RUN PRESENCE Continue to produce if better ?in? than ?out? Fixed costs - must be paid whether produce or shut-down - ?sunk.? - not incurred because firm produces - not an opportunity cost. - not important for decision. EXAMPLE: Go to movie - benefit 10 ($). Buy ticket 7 ($). Loose it. Should I buy another ticket? 2010: LECTURE 26 3 DON?T BUY BUY Benefit 0 10 Variable Cost 0 7 Net Benefit 0 3 Fixed Cost 7 7 Overall Net Benefit - 7 -4 I get more net benefit by buying another ticket. Cost of lost ticket incurred whether I go or don't go - not relevant for decision. By going, I get benefit of 3 ($) to set against the cost of lost ticket - so overall experience not so bad. 2010: LECTURE 26 4 FIRM constructs its accounts similarly: DON?T PRODUCE PRODUCE Revenue 0 100 000 Variable Cost 0 40 000 Operating profit 0 60 000 Fixed Cost 140 000 140 000 Profit - 140 000 -80 000 By operating, it brings in more money than it incurs as avoidable costs It makes a profit from operating, and it uses this money to reduce the loss. Because fixed costs are fixed, making operating profit larger increases profit and is therefore desirable. 2010: LECTURE 26 5 FIRM: Produce if can make positive operating profit, or if TR $ VC 8 8 money in cost incurred by producing PQ $ VC 8 8 money coming in cost incurred by producing from typical unit typical unit 2010: LECTURE 26 6 min AVC = 5 (?000 $). If price $ min AVC - there are outputs for which price >AVC - there are outputs which can produce positive operating profits - offset fixed costs - produce. If price < min AVC - at all output levels price < AVC - do not produce. 2010: LECTURE 26 7 EXAMPLE: HOTEL OFF-SEASON Hotel off-season - reasonably empty - ?they can?t be making money.? - revenue is covering variable costs, not cost of hotel. - better to stay open. 2010: LECTURE 26 8 OUT OF SEASON IN SEASON CLOSED OPEN Benefit 0 100 000 500 000 Variable Cost 0 40 000 200 000 Net Benefit 0 60 000 300 000 Fixed Cost 140 000 140 000 140 000 Overall Net Benefit - 140 000 - 80 000 160 000 2010: LECTURE 26 9 EXISTING FIRM: SHORT-RUN OUTPUT CHOICE If firm is present: Curve A: MC of 25 th unit is 10 (?000$/unit) Curve B: if p = 10, maximize profits by producing all units for which MC # price, or produce 25 units. 2010: LECTURE 26 10 Curve A: MC of 45 th unit is 15 (?000$/unit) Curve B: if p = 15, maximize profits by producing all units for which MC # price, or product 45 units. Curves are the same! Example: accountants sent up lots of cost information. - tossed all except MC information. 2010: LECTURE 26 11 SUMMARY EXISTING FIRM: SHORT-RUN SUPPLY CURVE If price < min AVC = 5, do not produce. If price $ min AVC = 5 , produce: 2010: LECTURE 26 12 money coming-in exceeds costs associated with producing. Produce all units for which MC # price, or until MC = price. Supply curve is MC curve above min AVC. Otherwise 0. 2010: LECTURE 26 13 EXAMPLE United Airlines, General Motors 2010: LECTURE 26 14 MEASURING PROFIT Difference between operating profit and profit lies in which costs are included: Revenue: 100 000 lessVariable Costs 40 000 OPERATING PROFIT 60 000 less Fixed legal cost (interest due to bank) 70 000 ACCOUNTING PROFIT - 10 000 less Cost of shareholder funds 70 000 ECONOMIC PROFIT - 80 000 Operating Profit = relevant costs are costs incurred because firm operates (variable costs) Accounting Profit = relevant costs are costs for which firm is legally responsible: variable costs plus interest due bank 2010: LECTURE 26 15 Economic Profit = relevant costs are all (long-run) opportunity costs variable costs plus all fixed costs (interest due bank and opportunity cost of shareholder funds) 2010: LECTURE 26 16 From Lockheed Martin Corporation 1996 Annual Report debartol C:\Users\debartol\Documents\classes\econ 2010 micro principles\2010 lectures without clicker questions\2010 lecture 26.wpd