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Chap11 - Part II Profit Maximizing Choice...

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Part II: Profit Maximizing Choice: Pro- ducers (or “Firms”) In Part I, we thought about individual choice when maximizing happiness is the objective of the chooser. We now turn to the case where maximizing something more specific — profit — becomes the goal. We will refer to the agents in an economy whose goal is to maximize profit as producers or firms . From the beginning, however, I want to emphasize that the basic logic of choice that underlies our model of Part I applies also for producers. Just like consumers, they try to maximize something given the constraints that they face, except that what they choose when they maximize and what they face as constraints is now a bit different. Consumers choose goods and services to maximize happiness given their incomes and the prices they face. Firms, on the other hand, choose inputs like labor and capital ; they maximize profit — the difference between revenue and cost ; and they face the technological constraint that limits how easy it is to convert inputs into outputs as well as economic constraints arising from the prices of inputs and outputs. Thus, in place of goods and services as the object of choice, we now have combinations of inputs to choose; instead of somewhat ambiguous “tastes” we now have the more concrete objective of profit that is formed by the economic constraints of prices in the market; and we add the complication of the role played by technology. It is important to be clear from the outset, however, about what it is that economists mean when they use the term “profit”. Initially, this seems quite straight- forward: after all, profit is simply the difference between revenue and cost. But economists do not use the terms “revenue” and “cost” the same way that, say, ac- countants use those terms. Economic revenues include all those revenues that a firm collects by choosing to produce but not cash inflows it would collect regardless of whether or not it produced. If, for instance, the government offers a tax rebate to firms who paid taxes last year, this is not an economic revenue because it does not depend on what the firm does now. Similarly, economic costs are costs the firm incurs as a result of its current production decisions and not payments it must make regardless of whether or not it produces. If a firm has committed to paying rent for factory space over the next year, for instance, it has to make these payments regardless of its current production decisions — and so these are not economic costs of choosing whether or not to produce now. As a result, economists will often say that firms will choose to produce as long as they can make at least zero profit — and non-economists will sometimes look at us as if we were Martians when we make this statement. Why, they say, would anyone produce when they make zero profit? The 273
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274 answer is that economic profit counts all economic revenues and costs — including the opportunity cost of time that the producer devotes to the firm. If I make zero
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