Producer Behavior In Market Economy

Question 1

How does marginal analysis work?

Answer 1

Analysis of profit maximizing behavior usually done using MARGINAL ANALYSIS

I.e looks at the impact of small or incremental changes in production on costs and revenues

MARGINAL COST (MC) shows CHANGE in total costs of production when output is increased

MARGINAL REVENUE (MR) show CHANGE in total revenue when output is increased

For producers who are price takers marginal revenue is constant

I.e each time they sell an extra unit of output, they get the same price

Distinguish from TOTAL REVENUE- which is always INCREASING

Question 2

Draw a graph of marginal costs and revenue

Answer 2

Marginal costs and marginal revenue

Costs/ revenue

Diagram can be used to amylose profit maximizing behavior for producers

At low levels of output, it shows that increasing output is the right decision

Eventually the situation changes as increasing output ads MORE TO COSTS than it does to revenue

Costs increasing at a faster rate than revenue

Continuing to increase output - not consistent with profit maximizing behavior

Makes more sense to cut back output

Question 3

What is the optimal level in terms of profit max

Answer 3

Optimal situation in terms of profit max. Level of output to produce is q in the diagram

At Q on diagram MC= MR

Means extra costs of production are just offset by extra revenues received

I.e level of output at which profit is maximized

Question 4

What happens if producers revenue changes ?

Answer 4

If producers revenue changes it will impact on their DECISIONS

This could happen because

• the PRICE in the market place CHANGES
• MARKET CONDITIONS have CHANGED

In following diagram , MR curve has shifted upwards

Now makes more sense for producer to produce MORE GOODS, get MORE REVENUE

With a higher price and marginal revenue more is produced

Question 5

What happens if a producers cost changes

Answer 5

If producers cost change it also impacts on production decisions

Changes in COSTS shown by changes in MC curve

If production costs INCREASE,this is shown by a LEFTWARD -from MC to MC1

Production LESS PROFITABLE so output will decrease

A FALL in PRODUCTION COSTS -PRODUCTION INCREASES