Firms Objective: Maximize Profit

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Firms Objective Maximize Profit Profit
Total Revenue - Total Cost Constraints on the
Firm 1) Technological What is physically
possible 2) Information What is known to be
possible 3) Market (Economic) What is feasible
from a standpoint
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Costs Opportunity costs not Historical costs -
Historical costs are sunk (opportunity cost is
zero) Explicit and Implicit opportunity costs -
Explicit costs are paid in money - Implicit costs
are alternatives forgone Opportunity cost
without cash expenditure Example cost of using
own capital implicit rental rate
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Implicit Costs - Cost of using own capital
implicit rental rate Economic depreciation Inter
est forgone - Cost of owners entrepreneurial
ability Normal profit - Cost of owners labor
forgone wages Economic Profit Total Revenue -
All Opportunity Costs
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The Firm and Its Economic Problem
Economic Accounting

• Item
• Total revenue 400,000
• Opportunity Costs

Wool 80,000
Utilities 20,000
Wages paid 120,000
Bank interest paid 10,000
Total Explicit Costs
230,000
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The Firm and Its Economic Problem
Economic Accounting (cont.)
Sydneys wages foregone 40,000
Sydneys interest foregone 20,000
Economic depreciation 25,000
Normal profit 50,000
Total Implicit Costs
135,000
Total Cost
365,000
Economic Profit
35,000
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Efficiency Technological Efficiency Producing
given output using fewest inputs (i.e., on
PPF) Economic Efficiency Producing output at
least cost Note Technological efficiency is a
necessary condition for economic efficiency (why?)
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Technical and Economic Efficiency
Quantities of inputs Method Labor
Capital A Robot production 1
1,000 B Production line 10 10 C Bench
production 100 10 D Hand-tool production
1,000 1
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Technical and Economic Efficiency
(a) Four ways of making TVs Labor cost
Capital cost Method (75 per day)
(250 per day) Total cost Cost per
TV set A 75 250,000
250,075 25,007.50 B 750
2,500 3,250 325.00
C 7,500 2,500
10,000 1,000.00 D
75,000 250 75,250
7,525.00
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Technical and Economic Efficiency
(b) Three ways of making TVs High Labor Costs
Labor cost Capital cost Method
(150 per day) (1 per day) Total cost
Cost per TV set A 150
1,000 1,150 115.00
B 1,500 10
1,510 151.00 D 150,000
1 150,001
15,000.10
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Technical and Economic Efficiency
(c) Three ways of making TVs High Capital
Costs Labor cost Capital
cost Method (1 per day) (1,000 per
day) Total cost Cost per TV set
A 1 1,000,000 1,000,001
100,000.10 B 10
10,000 10,010 1,001.00
D 1,000 1,000
2,000 200.00
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Four market types - Perfect competition many
sellers, identical product - Monopolistic
competition many sellers, differentiated
products - Oligopoly few sellers - Monopoly
one seller