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Chapter 8

ECON-UA 2 Chapter Notes - Chapter 8: Marginal Cost, Opportunity Cost, Profit Maximization

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Marc Lieberman

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Basic question to analyze a firm's decision making?
What is the firm trying to maximize?
How do we look at a firm?
We will view the firm as a single economic decision maker whose goal is to maximize its owners’ profit
Profit is defined as the firm’s sales revenue minus its costs of production
Two Definitions of Profit
-Accounting Profit-Economic Profit
Accounting Profit
-Total Revenue - Accounting Costs-With a few exceptions, accountants consider only explicit costs,
where money is actually paid out.
Economic Profit
-Recognizes all factors of production, including implicit AND explicit costs.
What is the proper measure of profit for understanding and predicting the behavior of firms?
Economic profit, as it recognizes opportunity cost and explicit cost.
The payment for land
What do the owners of firms provide that earns them their payments?
Economists view profit as a payment for entrepreneurship, which is just as necessary for production as
are land, labor, or machinery. Entrepreneurs’ two contributions to production are risk taking and
Where do firms face constraints?
With both revenue and cost
Market Demand Curves
Tell us the quantity demanded by all consumers from all firms in a market
Demand curve facing the firm
-Tells us, for different prices, the quantity of output that customers will choose to purchase from that firm.-
Refers to only one firm, and to all buyers who are potential customers of that firm.- Shows the maximum
price the firm can charge to sell any given amount of output
Perfectly Competitive vs. Imperfectly Competitive Markets
- Perfectly competitive markets; they take the market price as a given.- Imperfectly competitive
markets; the firm must decide what price to charge.
If demand for the firm’s output is elastic (ED > 1), then lowering the price by a given percentage will cause
It will cause quantity sold to rise by more than that percentage. In that case, the firm’s total revenue will
If demand is inelastic (ED < 1), lowering the price by a given percentage causes quantity sold to do what?
It causes quantity sold to rise by a smaller percentage. The firm’s total revenue will fall
Where do a firm's limits come from?
First, the firm has a given production technology, which determines the different combinations of inputs
the firm can use to produce its output.
Second, the firm must pay prices for each of the inputs that it uses, and we assume there is nothing the
firm can do about those prices.
In the total revenue and total cost approach, we see the firm’s profit as what?
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