Ch5 The Behavior of Firms Cost-Benefit Analysis Method I (Highest Net Benefit)

1. Ch5 The Behavior of Firms • Cost-Benefit Analysis • Method I (Highest Net Benefit) • Method II (The Equimarginal Principle) • Firms in the Market Place • Revenue • Costs (Fixed, Variable, Marginal, Sunk)

2. Wheat sells for $5 per bu. Cost to plant an acre is $120 Net Benefit=TB-TC p # acres Total Benefit Marginal Benefit Total Cost Marginal Cost Net Benefit, 0 0 0 0 Farmer Jane has to decide how many acres to plant. 1 $200 (40bu.) $200 (40bu.) $120 $120 $80 2 $380 (76bu.) $180 (36bu.) $240 $120 $140 3 $540 (108bu.) $160 (32bu.) $360 $120 $180 4 $680 (136bu.) $140 (28bu.) $480 $120 $200 5 $800 (160bu.) $120 (24bu.) $600 $120 $200 6 $900 (180bu.) $100 (20bu.) $720 $120 $180 7 $980 (196bu.) $80 (16bu.) $840 $120 $140 Method I: Highest Net Benefit Method II: MB(x)=MC(x) (The Equimarginal Principle)

3. Method I: find where profit is highest.

4. Method 2: find where MR = MC

5. a new tax of $100 to all farmers, regardless of how much they grow. p # acres Total Benefit Marginal Benefit Total Cost Marginal Cost Net Benefit, 0 0 $100 - $100 Farmer Jane has to decide how many acres to plant. 1 $200 (40bu.) $200 (40bu.) $220 $120 - $20 2 $380 (76bu.) $180 (36bu.) $340 $120 $40 3 $540 (108bu.) $160 (32bu.) $460 $120 $80 4 $680 (136bu.) $140 (28bu.) $580 $120 $100 5 $800 (160bu.) $120 (24bu.) $700 $120 $100 6 $900 (180bu.) $100 (20bu.) $820 $120 $80 7 $980 (196bu.) $80 (16bu.) $940 $120 $40

6. Method I: find where profit is highest.

7. a new tax of $300 to all farmers, regardless of how much they grow. p # acres Total Benefit Marginal Benefit Total Cost Marginal Cost Net Benefit, 0 0 $300 - $300 Farmer Jane has to decide how many acres to plant. 1 $200 (40bu.) $200 (40bu.) $420 $120 - $220 2 $380 (76bu.) $180 (36bu.) $540 $120 - $160 3 $540 (108bu.) $160 (32bu.) $660 $120 - $120 4 $680 (136bu.) $140 (28bu.) $780 $120 - $100 5 $800 (160bu.) $120 (24bu.) $900 $120 - $100 6 $900 (180bu.) $100 (20bu.) $1020 $120 - $120 7 $980 (196bu.) $80 (16bu.) $1140 $120 - $160

8. A Change in Fixed Costs Total Benefit & Total Cost 1200 1000 800 600 Total Benefit $ Total Cost 400 Total Cost2 200 0 0 1 2 3 4 5 6 7 # of Acres

9. If the tax is not sunk, this is the scenario. Farmer Jane has to decide how many acres to plant.

10. Common Mistakes You can continue to produce where the MC>MB and the net benefit is still positive for a while, but the net benefit is still shrinking.

11. Profit Maximization Benefit is Revenue, TR = P*Q Net Benefit is Profit,  = TR-TC # bikes Price Total Marginal Total Cost Marginal Net Benefit, p Revenue Revenue Cost 0 0 0 105,000 - 105,000 1 100,000 100,000 100,000 125,000 20,000 - 25,000 2 90,000 180,000 80,000 150,000 25,000 30,000 3 80,000 240,000 60,000 180,000 30,000 60,000 4 70,000 280,000 40,000 220,000 40,000 60,000 5 60,000 300,000 20,000 270,000 50,000 30,000 6 50,000 300,000 0 330,000 60,000 - 30,000 7 40,000 280,000 - 20,000 400,000 70,000 - 120,000 Method 1: find where profit is highest. Method 2: find where MR = MC

12. Method I: find where profit is highest.

13. Method 2: find where MR = MC

14. Profit Maximization a change in Fixed Cost=$40,000 # bikes Price Total Marginal Total Cost Marginal Net Benefit, p Revenue Revenue Cost 0 0 0 145,000 - 145,000 1 100,000 100,000 100,000 165,000 20,000 - 65,000 2 90,000 180,000 80,000 190,000 25,000 - 10,000 3 80,000 240,000 60,000 220,000 30,000 20,000 4 70,000 280,000 40,000 260,000 40,000 20,000 5 60,000 300,000 20,000 310,000 50,000 - 10,000 6 50,000 300,000 0 370,000 60,000 - 70,000 7 40,000 280,000 - 20,000 440,000 70,000 - 160,000 Method 1: find where profit is highest. Method 2: find where MR = MC

15. A Change in Fixed Costs 500000 450000 400000 350000 300000 Total Revenue 250000 Total Cost 200000 Total Cost 2 150000 100000 50000 0 0 1 2 3 4 5 6 7

16. Profit Maximization a change in variable cost # bikes Price Total Marginal Total Cost Marginal Net Benefit, p Revenue Revenue Cost 0 0 0 105,000 - 105,000 1 100,000 100,000 100,000 135,000 30,000 - 35,000 2 90,000 180,000 80,000 175,000 40,000 5,000 3 80,000 240,000 60,000 235,000 60,000 5,000 4 70,000 280,000 40,000 315,000 80,000 - 35,000 5 60,000 300,000 20,000 415,000 100,000 - 115,000 6 50,000 300,000 0 535,000 120,000 - 235,000 7 40,000 280,000 - 20,000 675,000 140,000 - 395,000 Method 1: find where profit is highest. Method 2: find where MR = MC

17. A Change in Variable Costs

18. A Change in Variable Costs

19. Changes in Firm’s Behavior • Changes in fixed cost • Do not affect firm’s behavior • Exception: Fixed cost extremely high • If profits negative, firm will shutdown and exit the market at some point • Sunk costs • Costs that can no longer be avoided • Once accepted, do not change behavior • Changes in variable costs • Do affect firm’s behavior • Total cost curve shifts by different amounts at different quantities • Changes in marginal revenue • Affects firms behavior • Anything that affects demand affects marginal revenue Landsburg, Price Theory and Applications, 7th edition

20. The Equimarginal Principle (method II) Q=200, Total Fixed Cost(TFC)=$3,000, Total Variable Cost(TVC)=$7,000, Total Revenue(TR)=$11,000 a. What is profit? What is Average Cost(ATC)? What is Average Revenue(AR)? b. The marginal revenue from selling one more unit(MR) is $45 and the marginal cost of producing one more unit (MC) is $33. What happens to profit if you produce and sell one more unit? What will AR be? What will ATC be? Under this scenario, would you want to produce a 201st unit?  c. MR = $37 and MC = $39. What happens to profit if you produce and sell one more unit? Under this scenario, would you want to produce a 201st unit?  d. MR = $38 and MC= $38. What happens to profit if you produce and sell one more unit? Under this scenario, would you want to produce a 201st unit?  e. Now repeat these three scenarios a, b, c, d assuming TFC = $4100. Would any of your answers to b, c, d change? Why or why not?

21. The Equimarginal Principle (method II)