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17Lecture

# 17Lecture - LECTURE 17 PROFIT MAXIMIZATION MARGINAL COST...

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LECTURE 17 PROFIT MAXIMIZATION: MARGINAL COST & MARGINAL REVENUE Figure 16-3 and Figure 16-4 demonstrated, along with Table 15-1 from which the figures were derived, that the profit maximizing level of output is that level of output where the slope of the total revenue curve, marginal revenue (MR) is equal to the slope of the total cost curve, marginal cost (MC). Remember, this is where the vertical distance between the TR curve and the TC curve, or profit, is the greatest. Figure 17-1 shows the MC and MR curves from Figure 16-2. Note that on Figure 16-2, the MC curve crosses the MR curve at a level of output of 7 ounces per week. FOR ANY TYPE OF FIRM, THE PROFIT MAXIMIZING LEVEL OF OUTPUT FOR THE FIRM IS WHERE MARGINAL COST IS EQUAL TO MARGINAL REVENUE. 1 Look at the different possible levels of output. Ounces 1 through 6, inclusive, all bring in more revenue to the firm (MR) than they each cost to produce (MC). We should produce these units as we make a profit on each. Note that if we produce ounces 8 through 12, inclusive, each ounce produced costs us more to produce than it brings in as revenue to the firm. We should not produce these units as we take a loss on each. When MC = MR we make the most profit. Figure 17-2 puts it all together. Note that MC = MR at or near 7 ounces of gold produced per week. When the price of gold is \$600 per ounce, MR is \$600. TR is P X Q, or \$600 X 7 = \$4,200 per week. The MC of the 7th ounce of gold is \$590. We should produce the 7th ounce of gold. We make \$10 profit on it. At 7 ounces of gold produced per week, ATC is \$428.57 per week. (This number, as all numbers, is from our empirically derived Table 15- 1.) TC = \$428.57 X 7 = \$3,000 per week. 2 1 Since MC can initially start out above MR, and cut MR when MC is falling, and then cut MR again later when MC is rising, to be perfectly precise, the rule is the profit maximizing level of output for the firm is where rising marginal cost is equal to marginal revenue. 2 Remember, if ATC is defined as TC / Q, then if we have Q and ATC, as we do in this graph, then TC = ATC x Q. Note carefully the relationship between this graph and Table 15-1. The ATC of 1 oz = \$810. The AVC and MC of 1 oz = \$240. The ATC of 7 oz = \$428.57. The AVC of 7 oz = \$347.14. The vertical distance between ATC and AVC at any level of output is AFC.

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Graphically, TR is the area of the rectangle with a height of \$600 and a length of 7 ounces. TC is the area of the rectangle with a height of \$428.57 and a length of 7 ounces. Note the profit rectangle: E Eis the area of the rectangle with a height of \$171.43 (\$600 - \$428.57 = \$117.43) and a length of 7 ounces. (\$171.43 / ounce) x (7 ounces per week) = \$1,200 per week. 3 Examine Figure 17-3. Figure 17-3 depicts the MC and ATC curves for our Sun Devil Gold Mine, derived in earlier lectures. There is one difference. At a price of \$600 per ounce, the profit maximizing level of output for our mining operation is still 7 ounces per week. However, the ATC curve has been moved up, and now it would appear that we are making \$0 of profit each week. The minimum point of the ATC curve is tangent to the MR curve. Total cost appears to be equal to total revenue. This implies that profit is zero.
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17Lecture - LECTURE 17 PROFIT MAXIMIZATION MARGINAL COST...

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