Chapter 4 Flashcards
Define Average Cost
Average cost (AC) is total cost (fixed and variable) divided by total units produced.
- Average cost is irrelevant to an extent decision.
Define Marginal Cost
Marginal cost (MC) is the additional cost incurred by producing and selling one more unit.
Define Marginal Revenue
Marginal revenue (MR) is the additional revenue gained from producing and selling one more unit.
Sell more if MR > MC; sell less if MR < MC. If MR = MC, you are selling the right amount (maximizing profit!).
What are the relevant costs and benefits of an extent decision
The relevant costs and benefits of an extent decision are marginal costs and marginal revenue. If the marginal revenue of an activity is larger than the marginal cost, then do more of it.
Define Average Cost
Average cost (AC) is simply the total cost (TC) of production divided by the number of units produced (Q).
AC = TC/Q
Average costs often decrease as quantity increases due to presence of fixed costs (FC)
AC = (VC + FC)/Q
FC does not change as Q increases
Key note: Average costs are not relevant to an extent decision
Define Marginal Cost
Marginal cost is the additional cost to make and sell one additional unit of output (Q)
MC = TCQ+1 – TCQ
- Marginal cost is often lower than average cost (due to fixed costs) but not always
- Marginal costs are what matter in extent decisions
Review Extent Decisions
Examples of extent decisions:
- Should you change the level of advertising?
- Should you increase the quality of service?
- Is your staff big enough, or too big?
- How many parking spaces should you lease?
For extent decisions, we break the decision into small steps
- If taking a step provides more benefit than cost, take a step forward.
- If not, step backward
What is the relation of MR and MC to production and profit
Maxim:
- Produce more when MR>MC
- Produce less when MR
- Profits are maximized when MR=MC
