Ch. 9 Sec. 2

Ch. 9 Sec. 2 - chapter 9 Perfect Competition and the >...

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>> Perfect Competition and the Supply Curve Section 2: Production and Profits chapter 9 Consider Jennifer and Jason, who run an organic tomato farm. Suppose that the mar- ket price of organic tomatoes is $18 per bushel and that Jennifer and Jason are price- takers—they can sell as much as they like at that price. Then we can use the data in Table 9-1 to find their profit-maximizing level of output by direct calculation. The first column shows the quantity of output in bushels, and the second column shows Jennifer and Jason’s total revenue from their output: the market value of their output. Total revenue, TR, is equal to the market price multiplied by the quantity of output: (9-1) TR = P × Q In this example, total revenue is equal to $18 per bushel times the quantity of out- put in bushels. The third column of Table 9-1 shows Jennifer and Jason’s total cost. The fourth column of Table 9-1 shows their profit, equal to total revenue minus total cost: (9-2) Profit = TR TC
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As indicated by the numbers in the table, profit is maximized at an output of 5 bushels, where profit is equal to $18. But we can gain more insight into the profit- maximizing choice of output by viewing it as a problem of marginal analysis, a task we’ll do next. Using Marginal Analysis to Choose the Profit-Maximizing Quantity of Output Recall from Chapter 7 the principle of marginal analysis: the optimal amount of an activity is the level at which marginal benefit is equal to marginal cost. To apply this principle, consider the effect on a producer’s profit of increasing output by 1 unit. The 2 CHAPTER 9 SECTION 2: PRODUCTION AND PROFITS TABLE 9-1 Profit for Jennifer and Jason’s Farm When Market Price Is $18 Quantity of tomatoes Total revenue Total cost Q of output of output Profit (bushels) TR TC TR TC 0 $0 $14 $ 14 11 8 3 0 12 23 6 3 6 0 35 4 4 4 1 0 47 2 5 6 1 6 59 0 7 2 1 8 6 108 92 16 7 126 116 10
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marginal benefit of that unit is the additional revenue generated by selling it; this measure has a name—it is called the marginal revenue of that output. The general formula for marginal revenue is: (9-3) Marginal revenue == or MR =∆ TR / Q So Jennifer and Jason would maximize their profit by producing bushels up to the point at which the marginal revenue is equal to marginal cost. We can summarize this as the producer’s optimal output rule: profit is maximized by producing the quan- tity at which the marginal revenue of the last unit produced is equal to its marginal cost. That is, MR = MC at the optimal quantity of output. We can learn how to apply the optimal output rule with the help of Table 9-2, which provides various short-run cost measures for Jennifer and Jason’s farm. The second column contains the farm’s variable cost, and the third column shows its total cost of output based on the assumption that the farm incurs a fixed cost of $14. The fourth column shows their marginal cost. Notice that, in this example, the marginal cost falls as output increases from a low level before rising, so that the marginal cost curve has the “swoosh” shape described in Chapter 8. (Shortly it will become clear
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This note was uploaded on 04/13/2010 for the course ECON 1110 taught by Professor Wissink during the Fall '06 term at Cornell.

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Ch. 9 Sec. 2 - chapter 9 Perfect Competition and the >...

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