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1. Corporation and Proprietorships.2. Corporations which use stock have two

advantages: limited liability and transferability of ownership. Disadvantages: the corporate income tax and costs of incorporation.

3. Proprietorships have unlimited liability and can not be transferred. They do not have to pay corporate income tax, however. (New hybrid forms).

4. Firms in our theory produce output in order to maximize profit. Marginal Analysis will help us understand profit maximization.

Firms: Legal Forms

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Marginal Analysis1. Relationship between Total, Average, and

Marginal Magnitudes?2. You already have experience – you have been

calculating your ‘average’ since elementary school. Each test is a ‘marginal’ score.

3. Useful in Understanding Profit Maximization.4. Total Revenue is defined as Price multiplied by

Quantity.

5. MR is the change in TR when another unit is sold.

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Marginal Analysis - Demand

PriceQuantity

DemandedTotal

RevenueMarginal Revenue

Arc Elasticity (based on average Q and P)

75 1 75 7560 2 120 45 348 3 144 24 1.835 4 140 -4 0.912126 5 130 -10 0.753117 6 102 -28 0.434311 7 77 -25 0.35906 8 48 -29 0.2267

2.5 9 22.5 -25.5 0.14291 10 10 -12.5 0.1228

1. Note Relationship between elasticity and Marginal Revenue.

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More Marginal AnalysisPrice

Quantity Demanded

Total Revenue

Marginal Revenue

Arc Elasticity (based on average Q and P)

15 60 90014 66 924 4.0000 1.381013 74 962 4.7500 1.542912 83 996 3.7778 1.433111 96 1056 4.6154 1.670410 110 1100 3.1429 1.42729 130 1170 3.5000 1.58338 165 1320 4.2857 2.01697 190 1330 0.4000 1.05636 225 1350 0.5714 1.09645 250 1250 -4.0000 0.57894 270 1080 -8.5000 0.34623 285 855 -15.0000 0.18922 290 580 -55.0000 0.04351 294 294 -71.5000 0.0205

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Marginal Costs and Profit

Quantity Used Output

Marginal Product

Marginal Revenue Product Total Revenue Total Cost

Marginal Fertilizer

Cost Profit0 10 120 0 1201 15 5 60 180 150 150 302 25 10 120 300 300 150 03 42 17 204 504 450 150 544 58 16 192 696 600 150 965 73.5 15.5 186 882 750 150 1326 87 13.5 162 1044 900 150 1447 100 13 156 1200 1050 150 1508 110 10 120 1320 1200 150 1209 115 5 60 1380 1350 150 30

Output PriceFertilizer

Price12 150

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Profit Maximization1. Marginal Analysis

2. TR= PxQ

3. Calculus leads to MR=MC conclusion;

4. Alternatives to Calculus

5. AR = demand curve; marginal revenue curve must lie below demand curve

6. Profit maximized when TR-TC is greatest (vertical difference)

7. this implies slope of TR = slope of TC which means that MR=MC

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demandofelasticitywhere

PQ

P

P

QP

Q

PQ

Q

QP

Q

TR

QPTR

Also

MCMRso

QMax

MCMRQ

TC

Q

TR

Q

TCTR

)1

1()1(

0

Some simple Calculus

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The Intuition

demandofelasticity

wherePMRor

are

)1

1()PQ

QP-P(1=MR

1=Q whereQ)P(-P= MRSo

effect. P thisof because P thanless is MR

price. in down go whichunits Qfor QP

+unitlast of price=revenues bringsLast Unit

units. Q of instead sold units

1+Q when Revenuein RevenueMarginal

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D

MR

$

q*Max Profit

TR

TC

max Rev

Profit Maximization

Output

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AC

MC

D

MR

Profits

P*

q*

Another Angle

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The Firm's Inputs And Costs1. Fixed And Variable Costs.

a. Fixed Costs: Costs that do not change when output changes.

b. Variable costs: Costs that do change when output changes.

2. Long Run and Short run.

a. Long Run: A long enough period of Time such that all costs are variable

b. Short Run: A period of time such that at least one input (cost) is fixed.

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TC=FC+VC; TC/Q = FC/Q +VC/Q which is ATC= AFC +AVC

AVC

ACFixed and Variable Costs

AFCTotal Fixed

Total Fixed

P

Qq1

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Irrelevance of Fixed Costs if you stay in Business

1. Changes in Fixed costs don't alter profit maximizing P and Q because fixed Costs don’t impact Marginal Costs.

2. Fixed Costs do impact profits, and may cause firm to decide the leave industry.

3. Same with lump sum taxes.

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AC1MC

D

MR

Profits2

P*

q*

AC2

Impact of Fixed Costs on Profit

Profits1

AC*

AC**

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Economies and Diseconomies of Scale

1. What does this imply about the AC curve?

2. defined simply as whether or not AC rises or falls

3. long run AC Vs. short run AC

4. Distinguishing between economies of scale and improvements in technology very important.

5. Can firms have diseconomies of scale but industries have economies of scale?

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AC

Economies of Scale Dise

cono

mies of

Scale

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Long Run ACLRAC

SRAC1SRAC3

SRAC2MC2

MC3

MC1

Q1

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Do average costs fall over time, or is average cost downward sloping?

AC1990

P*

q*

AC1991

AC1992

AC1993

AC1994

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Can firms have diseconomies of scale but industries have economies of scale?

1. External Effects – Industry output effects the costs of individual firms.

2. Positive External Effects can cause AC for industry to fall even though each firm has upward sloping AC curve.

3. Used to explain apparent decreasing costs but multiple firms in industry.