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Managerial Economics (Chapter 7)
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Terms in this set (19)
Profit maximization
making the greatest economic profit possible
Total profit (or economic profit)
for a firm is equal to total revenue minus total cost, where total cost includes all opportunity costs associated with the firms activities
marginal profit
is the rate of change of total profit with respect to changes in the level of output
Marginal profit equation (pie sign is profit)
M(profit) = Change in T(profit) / Change in Q which = T(profit)2 - Total(profit)1 / Q(2) - Q(1)
Arc marginal profit
gives the average rate of change of total profit with respect to output between two levels of output
Marginal Profit can also
be found by subtracting marginal cost from marginal revenue. M(profit) = MR - MC......M(profit) = derivative of T(profit) / derivative of Q
Total profit
will be maximized at the level of output where total revenue (TR) minus total cost (TC) is at its greatest positive level. At this point, the slope of the TR curve (marginal revenue) will equal the slope of the TC curve (marginal cost)
MR and MC
are equal where profit is maximized
Total profit is maximized
where marginal profit is equal to zero, and MC is greater than MR at higher levels of output. Marginal profit is equal to zero but MC is less than MR at higher levels of output. In this case the firm will increase profit by expanding output
Marginal revenue
is the additional revenue the firm receives from selling another unit of output
Marginal cost
is the cost of producing another unit of output
Average profit
is the profit per unit sold. It is equal to total profit divided by quantity of output. It is also equal to price minus average cost.
The first order condition for maximum TP
is that the first derivative of the total profit function be equal to zero. Since T(profit) = TR - TC, then the first-order condition is that M(profit) = dT(profit) / dQ = dTR / dQ - dTC / dQ = MR - MC = 0, or MR = MC.
The second-order condition is that d(2)T(profit) / dQ(2) = dMR / dQ - dMC / dQ < 0, which requires that marginal revenue be less than marginal cost at higher levels of output.
Finding the precise level of output that would maximize TP
if the firms total revenue and total cost functions are known. For example, suppose the firm's total revenue function is TR = 100Q - 2Q(2), and the total cost function is TC = 30 +120Q - 5Q(2) + 1/12q(3). The total profit funciton would then be given by TR - TC or T(profit) = (1/12)Q(3) + 3Q(2) - 20Q - 30.
To find the level of output that would maximize total profit, we find the marginal profit function, set is equal to zero, and solve for the quantity of output. Therefore m(profit) = dT(profit) / dQ = -(1/4)Q(2) + 6Q - 20 = 0. To solve this equation, we first multiply both sides by -4 and then factor: Q(2) - 24Q + 80 = 0
and
(Q - 20) (Q - 4) = 0
Thus at Q = 20 and at Q = 4, marginal profit is zero
Profit maximizing rule (or loss-minimizing rule)
is to produce up to the point where marginal revenue is equal to marginal cost and at higher output levels marginal revenues is less than marginal cost, as long as price is greater than or equal to average variable cost in the short run or long average cost in the long run
Break even output equation
Q(bep) = TFC / P - AVC
(P - AVC)
is called unit contribution margin
Incremental profit
is equal to incremental revenue less incremental cost resulting fro a specific change in the activity of a firm.
Incremental revenue
is the additional revenue that a firm will receive by undertaking a particular project
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