Production Economy Notes

Chen Li Supervision 4: Firm Microeconomics, Paper 1, Part I Elisa Newby Essay What economic factors will determine whether a good that is technically feasible to produce will be produced? First of all, we assume that firms produce in order to maximise profits. If producing a good does not yield a profit but a loss, the firm will shut down in the long run. Thus, a good will only be produced if it yields nonnegative economic profits in the long run. Profit in turn is determined by revenues minus costs. Revenues are the price of a good times its quantity. In the case of perfect competition, the price facing a producer is constant, so the firm can sell any amount of output. Revenue increases proportionally to the quantity of output. For a monopolist, the price he can charge changes with quantity, because he faces a downwardsloping demand curve. Therefore, there is an optimal level for revenue, which is the point where demand is unitelastic. Costs are derived from the price of inputs and can be split into fixed costs and variable costs. In the short run, fixed costs must be paid regardless of the amount of output produced. Variable costs occur when output is produced. The marginal cost is the cost of producing an additional unit of output. A firm will maximise its profits if it produces up to the quantity where marginal cost equal marginal revenue. For a perfectly competitive firm, this will happen when marginal cost equals the market price. For a monopolist, this point is the intersection between the marginal cost curve and the marginal revenue curve. In the long run, the firm will only produce output if it can cover its costs, which means that the equilibrium price must equal or be greater than average total cost. Average total cost is fixed cost plus variable cost divided by the number of units produced. If the price is lower than average total cost, the firm 1 

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