AAEC 2305AAEC 2305Fundamentals of Ag EconomicsFundamentals of Ag Economics

Chapter 4 – Continued

Costs, Returns, and Profit

Maximization

Maximization : Maximization : Total Output BasisTotal Output Basis

Objective is to determine output level that will maximize profits.

Producer compares total revenue to total cost at each pdn level to determine that output level that will maximize profits

Total Revenue CurveTotal Revenue CurveTotal Revenue (TR) – amount of money

received when the producer sells the product.• TR = TPP * Py • Since firm is a price taker, firm sells each

additional unit of output for same price.• T/F, the added revenue from each additional

unit of output sold is Py• T/F, TR is linear with slope equal to Py

Revenue CurvesRevenue Curves

Diagram TR, TC, TVC, and TFCFirms will continue to expand pdn as long

as increase in revenue is greater than increase in costs.

= TR – TC

T/F, max will occur when distance between TR and TC curve is greatest

Example – Table 4.3 pg. 85Example – Table 4.3 pg. 85Assume TFC = $10, Px = $4, and Py = $3Assume TFC = $10, Px = $4, and Py = $3

Given this information, Calculate TR, TFC, TVC, TC, and Profit.

Furthermore, determine the maximizing level of output use.

X Y

0 0

1 2

2 5

3 9

4 11

5 12

6 11

Decisions Under Decisions Under Changing PricesChanging Prices

How are output levels adjusted when facing changing input or output prices?

Changing Output Prices-– If output price ’s, the level of revenue earned

at each level of output changes.

Changing Input Prices – – If input price ’s, the total cost incurred at each

level of output changes.

Maximization:Maximization:Per-Unit Output BasisPer-Unit Output Basis

Most managers do not make decisions looking at TR and TC. Most decisions are made at the “margin.”

The output level that will maximize is determined by comparing the amount that EACH ADDITIONAL unit of output adds to TR and TC.

Recall, MC represents additional cost from producing an additional unit of output.

Per-Unit Revenue ConceptsPer-Unit Revenue Concepts

Average Revenue (AR) – average dollar amount received per-unit of output sold (produced)• AR = TR / TPP = Py

Marginal Revenue (MR) – addition to TR from selling (producing) an additional (one more) unit of output.• MR = TR / Y = Py

Per-Unit Revenue ConceptsPer-Unit Revenue Concepts

Since the firm is a price taker, Py does not with output levels. T/F, MR always equals Py.– Hence, MR and AR are graphed as a horizontal

line – If output price changes, the position of MR and AR curves change.

Additional revenue from selling an additional unit of output is equal to the price of that output.

Determining Determining Max: Max:Per-unit Output BasisPer-unit Output Basis

Combining per-unit cost curves with per-unit revenue measure, yields output level that will maximize .

Firm will continue to expand pdn until added revenue received from additional unit of output sold is equal to the additional cost of producing that unit of output (firm compares MR to MC)

Economic RuleEconomic Rule

Profits are maximized when added cost of producing an additional unit of output is equal to additional revenue from selling that unit of output.

*** are max when MR = MCDiagram MR, MC, ATC, AVC, and AVC

Example – Table 4.5 pg 90Example – Table 4.5 pg 90Assume TFC = $10, Px = $4, and Py = $3Assume TFC = $10, Px = $4, and Py = $3

Given this information, Calculate AFC, AVC, ATC, MC, and MR.

Furthermore, determine the maximizing level of output.

X Y

0 0

1 2

2 5

3 9

4 11

5 12

6 11

Decisions Under Decisions Under Changing PricesChanging Prices

Changing Output Prices– If output price changes (Py), the position of

the MR curve will change. Hence, the point where MR=MC changes and pdn changes.

Changing Input Prices– If input price changes (Px), the MC and ATC

curves will shift reflecting the change in the input price. Hence, the point where MR=MC changes and pdn changes