Okay, we've got a lot to cover. It's getting to the end of the term. I can't believe it.
Anyway, this is the way it is.
Okay, we have dollars, the usual demand curve, which we carried over from the first part of the course.
Price on the y-axis, quantity on the x-axis.
The demand curve is falling. Total revenue can either go up or down, depending on the elasticity.
TR is equal to price times quantity, and the other curve here we have dollars on the y-axis,
quantity on the x-axis.
We now have a TR curve, which can either go up or down, except it obviously can only go
up from the point of origin, since it starts at zero.
If you produce and sell zero TV sets, like I sell no TV sets, and therefore my total
Total revenue from selling TV sets is zero.
We start at the point of origin, zero quantity, zero total revenue, and a total revenue curve
then has to go up from zero, and goes up, and then either goes up or down, except we're
in some kind of peak trough situation, to the extent that it goes up, the demand curve
is elastic.
In other words, this is the area when the total revenue is increasing as quantity increases,
This is the definition of the man curve being elastic, in other words, as quantity increases, like so, and total revenue is going up, this means that the man curve is elastic in that zone.
So this is elastic the man curve.
Then as it goes down, the definition of that is that the man curve is inelastic, in other words, as the quantity goes up, we now get into a situation where total revenue declines.
And so, let's say here, as the state total revenue is now less, so in that situation we have an inelastic demand curve, and that goes up again, elastic, and then inelastic.
So in the textbook, as I mentioned last time, all these problems are resolved because there's just one peak.
In other words, the total revenue curve is drawn like this, and so in that situation it's very easy.
If it's elastic here, then it becomes inelastic, but it doesn't have to be only one peak, it could be several peaks, so I'm drawing it this way to show that in real life it can be multi-peak.
Okay, so you have the total revenue curve, which goes like that, meaning you don't know whether it's going up or down at any given moment.
It could be either way.
The total cost curve, which I went through last time, is always going up.
Total cost curve starts off at zero, the point of origin, regardless of what the book says.
In other words, if I am producing no TV sets, I produce no TV sets, I sell no TV sets, therefore
my cost incurred in producing TV sets is zero.
I start at the point of origin.
All the rest of the stuff is purely short run.
In other words, if I happen to be on a motorola producing TV and I'm retooling for six months
because the TV sets aren't selling, I might be having fixed costs, because there really
are no fixed costs in these sort of long run sets, okay?
Yeah?
Well, not if you're not in the business, I mean, you don't have to be in, nobody's compelling
you to be in the business of selling TV sets, okay?
In other words, I'm not, obviously in some short run situations, before you're, as you're
You're gearing up, you have costs and then you have revenue.
But there's nothing to compel you in the long run to stay in business if you're not selling
anything.
The point is that there are no fixed costs after a short run.
There are short run fixed costs, but there are no real fixed costs in any real philosophic
sense so to speak.
Also, the variability of the costs are varied for any given unit, any given plant.
Plants are more or less fixed, machines are less fixed, et cetera, et cetera.
So, there are different divisibilities. I'll get into that later on today. But the point
is there are no fixed costs. Nothing is fixed. If you're losing money in this business, you
get the hell out, you sell the plant, you close down, you sell the plant, you sell it
for scrap if necessary. You're firing somebody, you stop, you break your lease, you leave,
or you transfer the lease to somebody else, and then you get out. So, so-called fixity
is only very short run. There's nothing imposed upon you by the divine commandment that some
things are fixed and other things are variable. Everything is variable at the point in time.
All costs are variable at different degrees. Some costs are easier to get rid of than others.
For example, if you're in the TV business and you decide to get out, you can immediately
The aim of every firm is to maximize its profits or to minimize its losses, and therefore they're
trying to get in a situation where there's the biggest distance between total revenue
to maximize PR minus PC or profits. If there are luck holes in a good shape, this will be positive. In some cases, it can be negative. In some cases, you might have this kind of a situation. A total cost curve like that and a total revenue curve like that, then you're in really bad shape. Whatever you do, you're going to lose money. Eventually, of course, you go out of business. You raise tuition.
That's not a market activity.
So anyway, the maximum profit point of production you try to produce so that you maximize your
profit, the maximum profit, one of the attributes of maximum profit point of production is that
the slope of the tangent of total revenue and total cost are the same.
So that if the slope of the tangent of TR and TC are the same, then you've got marginal
Marginal revenue is equal to marginal cost. Marginal revenue is defined as delta TR over
delta Q. In other words, if you produce one more item, one more TV set, one more package
of nails, whatever you're selling, produce one more item. How much more total revenue
will be brought in by that one more item? That's essentially the slope of the tangent.
If you have an infinitesimal degree, the delta becomes infinitesimal and becomes dT or dQ.
Marginal cost is also, the reason why I prefer to stick to delta is that in real life, nothing
is infinitesimal.
In human action, buying or selling or producing, it's not infinitesimally small, infinitesimally
small.
This is dTc over dQ.
So, in other words, if you produce and sell one more unit of the item, how much will this
extra unit cost you?
And so, the maximum profit point is when the two are more or less equal, when the delta,
the marginal revenue and marginal cost are equal.
Now the thing is we should not make too much of this because once you realize there can
be more than one peak, as the textbooks never realize, then you can also have a minimal
profit.
Profit. It could be in this situation, the tangents are equal here, the slope of the
tangent is equal and yet you're in very bad shape. Also equal up here, you don't know
off-hand which is bigger, this or that, unless you actually inspect the data and find out.
So the marginal revenue equal marginal cost criterion is a very weak one. It only applies
if you have only one peak. And it's better if you have the data, if you're a businessman,
It's much better to figure out what the total is and not worry about the margin.
Really the only important thing about the margin is that it emphasizes the fact that
every step that a businessman takes, every decision a businessman takes, every new unit
that he produces, he has to worry about covering costs.
He has to figure he's not going to do it unless at least he covers costs, his revenue and
costs are equal for this decision.
Hopefully the cost is greater and the revenue is greater than the cost.
That's the major, philosophically important, so to speak, of concentrating on the margin.
The rest of it is mostly overblown, and the importance is really overblown of this.
Okay, average, average revenue is TR over Q.
In other words, if you want to find out, if you're producing, you sell, if you're producing, sell 100 units of something,
100 packages of Wheaties or 100 loaves of bread or whatever, what's your average revenue?
It's going to be the total you get, total income divided by the quantity.
and the income per loaf of bread or income per TV set, which of course is the same thing
as the price.
In other words, T times Q is equal to TR.
So average revenue is the same thing as price, it's another name for price of something.
If somebody sells ten loaves of Wonder Bread and gets ten bucks for it, it means the price
of the Wonder Bread, the average revenue of the Wonder Bread is a dollar per loaf.
So this is our old friend the demand curve. This is the demand curve, the price curve so to speak, relating price and quantity.
Marginal revenue, I mean average cost, is equal to total cost per unit, total cost divided by Q.
Also you can call it average total cost to clearly distinguish, we're not talking about average fixed cost, average variable, all this sort of nonsense.
I will not talk about fixing variable costs from now on.
When I talk about average cost, it's average total cost, average cost, total cost per unit.
It costs you $100,000 to produce and sell 10,000 items, and therefore the cost per item is 10 bucks.
That sort of thing.
Okay, now the relationship between marginal and average.
There's a certain relationship between all margins and all averages, and we'll get to that later.
We'll get to the labor market and the factory production market, too.
It's a purely mathematical relationship. It has nothing to do with economics, but it's used in economics, so we should go through it.
The relationship is as follows.
Supposing, for example, we take the average height of this class.
Each of us has a certain height. We total all the heights, and we divide it by whatever it is.
It's 20 people, and we get the average height.
Two basketball players walk in, and seven footers.
Then we take another average and of course it's going to pull up the average, not as much as 7 feet, but it's going to pull it up from whatever it is, 5'8 or whatever it is, to 5'9 or something.
In other words, if an average, if an average of x is increasing, then the marginal x is higher than the average, the average of x.
In other words, if you see an average going, if an average is increasing, like the average
height of a class increases from now to a half hour from now, it means a new guy coming
in, new people coming in, are higher than the average.
That's why the average is going up.
In other words, the increased margin pulls the average up.
So if you have an average of anything, it's not just the height, it applies to anything.
Average income, average weight, average whatever, intelligence quotient, whatever happens to
If the average is going up, that means that the marginal of the thing, average of x, the marginal of x is higher than the average, whatever it is.
On the other hand, the same thing applies to the other direction. All these laws are symmetrical.
If we take the average height and two midgets walk in, two four-footers, it's going to pull down the average.
If the average of something is decreasing, then the marginal of x is less than the average
of x.
So, in other words, if you see an average of something decreasing, it means that the
The margin is pulling down the average. These two midgets or three midgets, whatever it is, are pulling down the class average in height.
So, this is the other law. It's symmetrical to the first one.
So that means if you have an average of anything as decreasing, it means that the margin is below the average.
Here we have an average of something. It doesn't matter what it is. Let's say height. It doesn't matter.
And this average is going up, so it means that the margin is above it somewhere, and if the average is going down, it means the margin is below it somewhere.
The margin is the average.
Well, okay, if in that case, this is pretty obvious, but in that case it means that when the average reaches a peak, it reaches a peak point, which means it's constant for that moment, of course.
And the average utility, it must mean that the marginal is equal to the average, it's the only way you can cut through, you can't leap across the dimension here.
So it must mean that at the point where the average flattens out before it falls, the marginal is equal to it.
In other words, this follows from these two points, these two axioms here, whatever you want to call them, propositions.
So, therefore, when the average of x is at a peak, in other words, when it's constant,
then the average of x is equal to the marginal of x.
And also it works for the trough point.
In other words, the average is going down, the average is something, and then it goes
When it goes up and it goes down, the margin is below it somewhere, the marginals, when
the average is going up, the marginals above it, the average.
This means that when the average flattens out and becomes a trough of the trough point,
the marginals must be equal to it.
So this is, okay, so when the A of X is either a P or a trough, because at a peak or a trough,
the average is constant for that moment.
and the average of x is equal to the margin.
This applies to all averages and all marginals.
FAT-MAC applies to everything in life, just in economics we just build a few things here,
but you can carry it over to all of life now.
You have this great piece of knowledge which can serve you in good stead forever in all
fields of endeavor, height, weight, IQ test or whatever.
In the case of microeconomics, the average costs, as we'll see in a minute, average
costs tend to have a U-shape, something like that, you'll see why, average total cost
or average cost.
Something like that.
In other words, it declines, reaches a throw-off point, and then goes up.
This is dollars on the y-axis, quantity of goods on the x-axis.
We haven't demonstrated this yet. I will demonstrate this a little later. If it has this kind of a U-shape, then marginal cost will always be below it when it's declining.
It will always be above it when it's going up, because it follows. When the average of anything falls, the marginal is below it, below the average.
When the average of anything is going up, the marginal has to be above the average.
When the average of anything is at a trough point, the marginal is equal to it.
So, therefore, marginal costs, if the average costs really have some kind of a U-shape,
kind of shape, then the marginal costs will be something like that and they will equal
each other at the trough point.
For revenue, it's a little bit different because since the demand curve is always falling,
The man is equal to average revenue, so the average revenue is always falling.
This is a rising average revenue curve.
So the marginal revenue will always be below it.
In other words, this average revenue is always falling.
This means the marginal revenue is always below it.
It will be like this, matter of fact.
Eventually it will hit the x-axis for that matter.
It will keep going like that.
So this accounts for the shape of the marginal curve in the book.
In other words, given the average curve, because the man curve is always falling, as I've said
to that, the marginal curve is always falling, it will always be below it and will actually
fall more steeply, you could say that, and if the average curve is U-shaped, and I haven't
demonstrated that yet, then the marginal curve will be something like that, hitting, intersecting
at the trough point.
So this is all really mathematics, it's now applied to microeconomics, and later on we'll
Let's see how this applies to productivity curves, things like that.
Okay, let's get to the average cost curve, then,
why a few shake or whatever. When you think of economy
of large-scale production, those of you who have walked with the idea of a total cost curve
is always going up, and you say, no, no, but total cost, how about a normal meal plan, isn't it less
costly to have a large-scale production? It's true, but for average cost that you're talking
about, average total cost.
Let's look at the average course curve, it's not as simple as you might think, why it's
something like U-shape.
Now we get to some more philosophic mathematics, so to speak, this is philosophy of life of
mathematics applied to it.
We have it in real life, so to speak, law of cause and effect, which essentially says
given the causal factors, given a certain quantity of causal factors, it will yield a certain result, a certain effect, and this cause and effect relationship can be replicated at any time or place.
In other words, you can set side by side, you can produce whatever it is, you can produce copper sulfate in a certain way, you can produce the same copper sulfate next week or two blocks away and so forth and so on.
So this is a basic law of life, that equal causes yield equal effects, that they have a natural law situation, called natural law of nature, natural law situation.
Okay, we can express this, we can express this natural law situation in production by a mathematical formula, by a generalized mathematical formula called the production function.
It's a very general law, but it expresses certain basic truths.
When a production function says it relates, it says as follows, given, it applies to all
production of anything.
It really applies to any kind of action for that matter, any kind of quantitative action
of any sort.
I mean, to buy a sandwich, you have to do certain things.
You have to go downstairs.
You have to go to Michelangelo's.
They've got the sandwich and all that sort of thing.
You pay a certain amount of money, you leave that out.
It's a physical production function.
What you're saying is this, to produce anything, you need certain end factors of production,
you need a certain amount of labor, land, capital, certain types and so forth and so
on.
A certain quantity of each factor, a factor x, a certain quantity alpha, whatever the
quantity is, five of it, three of it, it will differ from good to good, it depends on each
good and service, it depends on the technology of it.
The alpha of x, combined with, this is a symbol for combined with, combined with beta, a certain
quantity of y, factor y, combined with a certain gamma, a certain quantity of factor z, combined
Combine with a bunch of other factors, dot dot dot, will yield a certain quantity of
a product.
Q of, I don't know, what's, Q of P?
P is usually price, let's make it R. Q of R, Q of a certain product.
In other words, you take a certain number, a certain amount of factor of X, combine it
In a certain way, with a certain amount of factor Y combined with a certain amount of factor Z, step by step you will get five eggs or three TV sets or whatever it happens to be. You get a certain quantity of a product.
This applies to any product of any sort. It doesn't matter what the actual service happens to be.
This is a generalized production function. Since you have a law of cause and effect, you can replicate it. You can put it side by side somewhere and duplicate it.
So you'll have then alpha of x combined with beta of y combined with gamma of z, etc.
Side by side will produce another q of r, another three t v sets or another 28 loaves
of wonder bread, whatever it happens to be.
So this means that you can keep adding indefinitely.
So therefore, instead of doing that, of course, you can multiply each of these factors by
n.
So this means that n times alpha, minus n times beta, minus n times gamma will yield n times the product.
This is purely, this follows the law of cause and effect.
So this is our generalized production function. Those of you who are mathematical mavens,
this is also called a linear homogeneous production function.
Don't ask me what this means, because I'll just state it.
So, this means that from the physical point of view, just from the point of view of physical product, physical factors or whatever,
if you're a business firm now, to get back to the firm, and you're hiring factors and you're producing certain things and getting the product,
this means that the average cost of everything should be constant.
should be constant. In other words, if to produce, I don't know, produce 100 loaves of wonder bread, you need alphas or whatever, to produce a thousand, you need 10 times as much, and we've just said this through our basic law of linear homogeneous production sponge.
So this means that the average therefore cost, this is dollars, means you need five times as much of everything to produce five times of a product, so therefore it should mean that the average cost is horizontal.
The average total cost would be horizontal.
And since it's obviously not horizontal, the question is how come?
come. Here we have a real problem. It obviously does not cost. If you want to produce one
car a year, you're not going to build a $100 million automobile plant with all the equipment
and grind out with one car because you have an astronomical cost per car. You have a huge
fixed cost in situations like that. One thing that violates, by the way, of course, is when
the price goes up, as we'll see later on, even more. If you keep producing more and
If you're going to buy more of this thing, grinding out many n's, in other words, losing
ten loads of money, about ten cars, a hundred, a thousand, a million, you're going to start
bidding up the demand curves of the various factors of labor, in other words, you're buying
more, demanding more labor on raw materials or land, you're going to bid the prices up,
so the wage rates and raw material prices and all those things will go up.
So eventually, even if everything was constant, because of the prices going up, the price
The price of the factors of production, the cost from the point of view of price, in other words, the price of labor, the price of land, low material, you'll have something like that, so you'll have an average cost that will then go up.
But the real problem is what about the sloping cost, which we know, we know of course that the average cost falls over a long distance when you start producing.
So the question is, where does that come from? Why does it have a falling average cost fair?
Why is it more economic to have a huge assembly line for automobiles producing a million cars a year instead of five cars a year?
Cards a year. Why is it much costlier to have a small automobile plant? And we haven't explained
that yet. So in other words, with the philosophy, we have the constant average cost curve, and
then knowing that an increase in demand curve will raise the price of raw materials and
labor etc., we're going to explain the average cost curve going up at the toe of the end.
What we can't explain yet is why it falls on the early parts of production.
The reason why it falls, allegedly violating all of this law of linear homogeneous production factor, doesn't really violate it.
The problem is, you can't multiply everything by n in real life. That's the problem.
In other words, you can't take n times nq.
You can't multiply each thing by n, because each factor of production is a different divisibility.
This is the so-called indivisibility problem.
You can, for example, multiply paperclips by n.
If you're increasing the production of something by tenfold, you're going to have ten times as many paperclips.
There's no problem with that.
Or ten times as many nails, or something like that, which are very divisible.
In other words, some factors of production, some capital goods are very divisible, others
are very indivisible, just the nature, the technological nature of them is very indivisible.
You can't multiply a plant by a factory by ten, right?
You can have ten times as many machines, maybe, but you can't have ten times as many factories.
The most, the famous case of a very indivisible, there are different degrees of indivisibility.
This is why I'm getting back to this gentleman's point about fixed costs.
There are different degrees of fixity, there are different degrees of variability.
The problem with the textbook they say some costs are fixed and others are variable. Everything
is variable but at different degrees. For example, the most famous case of a very indivisible
capital good is a railroad track. Let's say you have a railroad going from here to Boston
and you're increasing, you're doubling the amount of shipments on it because you have
more business. Well, you can double the number of railroad cars maybe. You can double the
number of railroad workers and engineers and firemen and stuff. You can't double the track.
The track, the double track is a big thing, a big deal. It takes a long time. You have to lay the track and all the rest of it. It's not very easy.
You have different degrees of indivisibility. Railroad track is one of the least indivisible things I can think of, one of the most indivisible things.
Factories are quite indivisible. Machines are less indivisible than different machines.
Law material is very divisible, you can get more, you know, law material coming through pretty easily.
Labor has different degrees of divisibility, et cetera, et cetera.
And some things like paper clips are very divisible.
So, in practice, you can't increase everything by n.
Some things can be doubled, other things can't.
Some things can be tripled easily.
You can quadruple, say, this before you can double this.
And so, it's because of that, because of these degrees of indivisibility,
In other words, you start with a plant. Let's say you're producing automobile. You start
with a huge plant with a big equipment and all the rest of the stuff before you can produce
anything. You produce one car a year. You've got an enormous $100 million per car cost
because you have this enormous cost in order to gear up those things because these are
all very indivisible. You have a stratospheric average cost problem. As you keep increasing
In other words, then you begin to have very rapidly decreasing as you start using this
very indivisible machine.
It's like a big computer.
You have a huge mainframe computer, like in the old days, think you have to use it a lot
to make it efficient, bring down like average cost per unit.
As you increase the units of production, you have a very rapid fall in average cost as
you keep tapping more and more of the indivisibility, you start using this very indivisible, it's
It's like picking a $100 million machine or whatever and using it only once a year, one
hour a year.
It's crazy.
It's a very high average cost per unit.
As you keep using it, you lower the invisibility and as you keep increasing the quantity, more
and more of the invisibility are tapped.
In other words, you're using it in more and more capacity production.
As you do that, you finally level it off and you finally begin to use it at capacity.
Most entrepreneurs, when they're building a plant, are thinking of a certain range of
production they're going to use it, you know, a hundred million cars a year or something.
They will design a plant in such a way that it will be the most efficient or lowest average
cost, more or less at a million a year.
I mean, this would be a certain range, because it's not God-given, it's going to be the
same number of cars for ten years or twenty years, but more or less they know the range.
Nobody thinks of producing one car a year.
When the automobile industry first started, they grew up in blacksmith shops around 1900,
small blacksmith shops, bicycle shops.
They produced one car a year or ten cars a year or something like that.
They were geared for it.
That was the most efficient.
The lowest average cost is more or less at ten cars a year, but after they start going
into mass production, the whole thing changes.
So as you keep increasing the quantity, you finally get to the point where you're more
or less using everything in capacity and you start overusing things.
And as you keep going, you start overusing various products.
You can't gear it in such a way that everything meshes together at once.
So as you keep increasing the quantity, you start having problems with overuse, breakdowns
of Equipment, and the average costs begin to turn up.
And then you have, finally, as you get big mass production, the factor enters in of increasing
the price of wages and more material, in other words, you have an average cost turning up
because the price of the factors of production goes up.
As a result of all this, you have something like a U-shaped average cost curve.
Because of the problem of indivisibility, you have to get to the point where you're
using up the indivisibility, you're tapping the, you know, using the capacity of all this
fixed equipment.
But there are different degrees of indivisibility, it's not just some things are fixed and other
things are variable.
Everything is variable except at different paces, at different rates, and so the best
way to mesh them together is somewhere around here.
It's still not totally meshed together because life doesn't work that way.
So you have something like a U-shaped average cost curve, that's the final conclusion,
And more or less, you hear it, of course you're usually operating around here, in this area.
And if you talk to a business man, if an economist talks to a business man about their falling
average cost, they don't usually know what you're talking about because they don't think
in terms of producing one car a year, or two cars a year, obviously they're thinking in
terms of producing a million or so, they're not geared in these kinds of hypothetical
situations.
So most businessmen think, of course, average cost is more or less constant because they're
We're dealing in a zone here, more or less in this area.
As a matter of fact, probably empirically, in most situations, the average cross-curve,
there's nothing that says it has to be U-shaped.
All we know is it starts off very high, it declines, it reaches a cross-point and then
goes up again.
And so usually empirically, it's generally something like this, goes down like this and
there's a plateau and then it goes up.
So most businessmen think of their average cost as constant, because they're dealing
of course in practical reality in this plateau area.
They don't deal in the areas where they start having big increases in costs or areas where
they're only producing five cars a year or something.
So more or less you have this plateau situation.
And in this situation of course marginal cost will be somewhere below it.
When average costs are falling, marginal costs are below it, usually around here somewhere
marginal cost will be higher here, and of course it will intersect at the trough point
and again, too much is made of this in a textbook, I think this is a great thing to worry about the intersection
but basically the point is that marginal costs are set once you give an average cost
and in this situation here, where there's a plateau, marginal cost will be identical to average cost in this whole range
You have something like that, marginal cost like this, up like that, like that.
So, this is why most businessmen, if they talk about marginal cost and average cost at all, which they usually don't,
they say, well, it's all constant, it's all equal, and it is for them, and in the zone of practicality, it is equal.
I mean, because this is the region they're dealing with 99% of the time.
Okay, so this is the, this is basically the average cost, marginal cost, shtick.
It's of some use, certainly, the idea of indivisibility is important.
The average cost curve falling and then being constant and then going up again.
And the idea of marginality is important as an idea of focusing on the fact that businessmen
are interested in each decision.
They want to make a profit on each decision, or at least not make losses on any given decision
in their making during the course of the year.
Now we take the maximum profit point, or the maximum profit diagram, remember in our total
curve, where the total revenue is like that, and the total cost is like that, this is the
maximum profit.
In other words, businessmen, if they know the curves, which is a very big if, will tend to produce at this point, where the profit is at the maximum.
Transposing that to the average marginal curve, we have then the demand curve is like this, let's say.
Something like that.
And here's the average cost curve and then whatever.
And in this case, the marginal revenue curve would be like this.
and marginal cost curve will come up like that and remember that given the various assumptions,
given a one peak curve, okay, beginning about multi-peaks, given a one peak curve, and given
this diagram, you can't automatically see what the maximum profit point is, you can in
this diagram, pretty obvious, you know, this is the maximum profit point, given only this
diagram, the only way you can figure out the maximum profit point is by taking marginal
Marginal Revenue Equal Marginal Cost is the criterion, in other words, this point right
here.
This will be the point of maximum profit for the firm given these curves, given the situation.
At this point, this point of production, let's say, this is a thousand widgets or whatever,
at that point, this is where marginal revenue and marginal cost are equal, the only point
where they're equal, at that point the total profit will be the following.
Total Profit, it will be average revenue times Q, or price times Q, total revenue, minus,
So this is, if you're looking at the averages, total revenue minus total cost, so this is
total revenue is average revenue, average revenue times quantity minus average cost
times quantity.
So this is the way, this is the way total, this would be maximum profit point, where
Now, it was at the point where marginal revenue and marginal cost are equal, average revenue
times quantity, the total profit will be average revenue times quantity minus average cost
times quantity.
In other words, this is average revenue times quantity here, this figure, minus average
cost down here times quantity.
So this, the total profit will be this area here, in other words average revenue minus
average cost times quantity, this will give you the total profit at the maximum profit
point.
In other words, at the point where marginal revenue and marginal cost are equal, you then
take this, this minus this, this is on the point-of-demand curve, minus the point-of-the-total
on the average cost curve, times quantity, giving you this area, this will be the same
as that, as this line here.
And this is a big, this is always big in the textbook, always giving you these examples
of problems except for finding the maximum profit point, let's grind it out that way.
In real life, of course, this is average to the total, why not go for the total, why worry
about the average?
This is the way it's done on the books.
Given only this information, the maximum profit will be the point where these marginal revenue
and marginal costs intersect, and at that point, the total profit will be this area.
Of course, if you're making losses, then you're in an unfortunate situation, such as as follows.
Here's the demand curve, and here's the average cost, and you're always below it,
and you're in bad shape.
This, I guess, will be the marginal cost
coming up like that, the marginal revenue. This will be like the minimum
loss point here. So you produce at this level, this will be the loss.
Of course, if you keep on like this, you go out of business
pretty quickly. I'm not going to hang around and make losses forever, but this
would be the minimum loss point. This would be the area of loss then.
textbook, at the point of intersection, marginal revenue and marginal cost, this would be the
minimum loss point where the average cost minus average revenue times quantities at
a minimum.
Hopefully, of course, usually in the textbook, this is the example because you're assuming
the firm is making a profit.
It doesn't have to make a profit, nothing, there's no divine law, it doesn't have to
make a profit.
So, anyway, this is essentially production. The theory of production of the firm is essentially
this, that the firm tries to make a maximum profit. A maximum profit is determined in
a one peak curve situation, one peak total revenue curve, and be at a point where the
slope of the tangents, in other words, marginal revenue and marginal cost are equal. So the
marginal revenue and cost and marginal cost curves intersect, and at that curve, you can
This line here in the total diagram is very simple. This is obviously much simpler.
Just look at this. This is the profit, total profit, this minus that.
In this curve it's more complicated. The area is subtract average revenue, average cost of average revenue multiplied by quantity, and that gives you the total profit.
Any questions on this?
This is the high-powered stuff of the month, yeah.
Given that you're operating altogether, as I say, you can see that for a certain wide you go out of business, this would be the minimum loss area.
All of this is loss because average cost is always above average revenue in this particular diagram, so this is the minimal point, given that you're operating at all.
So, and given a one peak curve, a one peak total revenue curve, if it's two peaks then all the bets are off, you have to look for the, you know, you have to look for the expected total, but as I say in the textbook they never talk about two peaks because that screws up the whole math and the whole geometry of it screwed up. You can't rely on tangents and all the rest of the things. Okay, let's take a ten minute break and get on the applications here of this analysis, maximum profits thing.
Supposing you're a business firm, you're here, you're producing this much, you're
in the inelastic demand curve zone, in other words, okay, so you're in this kind of a
situation, price and quantity, so that means that you're in a situation where you cut
your production, let's say this is 1500 units, you cut your production from 1500 to less
The total revenue goes up because you're in an elastic demand curve for the firm.
Therefore you will do it.
If a business man has any smarts at all, he will get the hell out of this situation because
all he has to do is to cut production.
When he cuts production, the total cost goes down, the total revenue goes up and he automatically
makes more money.
For a no-business firm which has any smarts at all will ever remain in this zone.
In other words, it will always be in this zone here, even if it doesn't quite hit the
maximum profit point, which is difficult to do, because you don't always know what your
demand curve is and what your cost curve is, if you see it all, all you have to do is to
cut costs and your total revenue goes up, you will do it.
So the conclusion is that every firm, every business firm will always be, will always produce
in an area where the demand curve is elastic.
In other words, this area here, this is the rising total revenue curve, the elastic demand
curve zone.
So that means every firm will have an elastic demand curve, because if they're in an elastic
zone, they'll get out of it, they'll cut production quickly.
The reason why they'll cut production is not to increase it, because it's very easy to
cut production.
If you cut production, the costs are lower and your total revenue is up, you will do it.
So, this area is not viable. No firm will be in it.
We have a very important conclusion here. The conclusion is that every firm will have an elastic demand curve.
It will be in an area where the demand curve is elastic.
We've already seen that the demand curve for the firm is more elastic than the demand curve for the industry as a whole.
because you have more range of choice for the consumer, Wonder Bread, Pepperidge Farm,
whatever, there's much more range of choice than bread, period.
But now we see more than that.
Not only will the man curve for the firm be more elastic than the man curve for the industry,
it will be elastic, period.
In other words, we'll be in a zone where if you increase production, cut prices, the total
revenue goes up, you raise prices, the total revenue will fall, the firm will always be
in this zone.
Because if the firm is in this zone, we're talking about a firm now, not an industry.
The firm will never be in this zone because it will always be immediately profitable to
cut production, cut costs and raise revenue.
No firm will, given any smarts at all, get me in a situation where I'm losing money by
producing more.
So every firm will have an elastic demand curve.
Now this really covers the theory of costs and demand.
We now get to the whole area of monopoly and competition, and the, I'm going to say it's
going to be much shorter than the stuff in the book, we have to deal with some case studies
of course, but basically, the problem with textbook microeconomics is in the 1930s they
erected a so-called ideal, which they've been getting away from ever since, I mean the micro
texts are much better now than they were 50 years ago, they still have not thrown over
According to the theory of so-called perfect or pure competition, notice the name is perfect
Perfect and Pure, a value-loaded terminology, although the economists claim to be value-free
and non-emotive.
Perfect sounds good.
If you say a situation is perfect or pure, it implies that it's a good situation.
It's better to be perfect than imperfect, it's better to be pure than impure.
Perfect competition or pure competition is defined as a situation where the man care
Whether the man curve for the firm is horizontal.
Instead of being simply elastic, whether the man curve for the firm is perfectly elastic
or infinitely elastic, that's supposed to be the best situation.
Why it's the best, we'll go into a little later.
To say it's unrealistic is putting it mildly, because it never exists.
What it implies is that, regardless of how much the firm produces, it won't have to
cut price.
We've already seen the mangroves are always falling.
How can it be horizontal?
The theory is, it's true that the mangrove of the industry is falling, but if each firm
is very, very tiny, say the wheat market is a classification of a big wheat industry,
each farm is only 100 acres or 10 acres, if Hiram Jones, wheat farmer in Iowa, increases
the production by 10%, it's not going to affect the entire wheat market.
On that basis, they claim that the demand curve for each farmer is horizontal, and that's
certainly elastic.
It's not really, because obviously, the angel Gabriel came to Hiram Jones and said, look,
I can magically increase your production by a million fold, it will affect his demand
curve.
I mean, he'll have to cut the price in order to sell it.
As a given production, it's very tiny compared to the rest of the industry, does not improve
a product, as a product is fixed forever, doesn't compete in any other spectacular way.
In that situation, the man curve would almost look like it's infinitely horizontal.
Why is that better?
Who knows?
There's certain alleged reasons for it that I think are all phony, but anyway, this is
supposed to be the ideal situation, a situation where competition is perfect.
Anything else?
In other words, in real life, where all the man curves are falling, even for Hiram Jones,
certainly for everybody else, every other firm, because if the firm increases, if it
doubles its production, it'll have to cut the price in order to sell it, it faces a
All real life situations are attacked as being, quote, imperfect or impure or monopolistic.
So the theory of monopoly we've inherited from the 1930s is this very weird theory where
the only real competition, the only perfect competition, is when each firm faces a horizontal
man curve, it says each firm a reality, including ourselves.
I mean, if you go in there, if you become an engineer and you charge your wage rate
You will face a falling demand curve. In other words, if you insist on tripling your salary, you're going to get a much lower demand for your services.
So everybody is a, quote, monopolist in that sense, or monopolistic. All life is monopolistic.
It's a very peculiar kind of terminology, you see, where everybody becomes a monopolist by definition.
So real life, when every firm or every individual or whatever faces a falling demand curve, it's called monopolistic, imperfect and pure.
Perfect and Pure. Notice, these economists claim to be value-free. They're scientists.
They're not passing moral judgments. But look at the moral judgment that's implicit in this.
On one hand, you have perfect and pure and, quote, competitive. And on the other hand,
you have imperfect, impure, and monopolistic. Obviously, value-loaded terminology. Attacking
this as being somehow evil. And the antitrust system, from the 1930s until about 20 years
was designed to try to force industry into this percussive bed of being pure, perfect,
and where every firm faces a horizontal macro.
Remember, it's a break-up industry, you have tiny little firms.
At any rate, this is, say the least, not only is it unrealistic, there's no reason to consider
this is better.
Matter of fact, it's worse to have pure competition than have so-called impure because the situation
every firm faces is so tiny, it's going to be almost horizontal macro, it's going to
I mean, one where every firm is so small, you're not going to tap economies of large-scale production. It would be very costly for the consumer and for everybody else.
But anyway, that's the whole schtick. The whole theory of monopoly is, and all the other terms, oligopoly, monopoly, imperfect, it's all the same thing.
It all means that a firm is facing a falling demand curve.
And notice what's happened here. What's happened here is that originally the terms of monopoly and competition, both in economics and in real life,
were defined very differently up until 30 years ago, 50 years ago. Competition meant
rivalry, it meant people competing for business services, it meant other people, other firms
coming in and competing, or other people coming in. That's what competition meant. Monopoly
meant government grants of exclusive privilege to one or more firms. As I've already talked
about, I'll talk more about now, when the government says only the yellow cap company,
The government grants exclusive privileges to one person or few people or whatever, keeping
out all other competitors.
That's monopoly.
That's what monopoly has always meant, until 50 years ago.
Then the economists come along and they change the definition, and everybody's against monopoly
for good reasons.
Because monopoly means, first of all, you're screwing the consumer, you're taking, you're restricting entry into a firm, into a taxi industry or the medical profession or whatever,
and you're deliberately then, by restricting entry, you're raising the price that the consumer has to pay and cutting the production.
And naturally, consumers are against it if they know what's going on, and competitors are against it. Those are excluded from this global racket.
And so the American Revolution, for example, is a revolution against monopolies, against the British East India Tea Company, given the monopoly of import of tea into the United States.
So, and most of the early state governments had a constitutional clause in the state constitution against monopolies, and that didn't mean facing a falling demand curve.
The Falling Demand Curve, it meant that the government may not grant exclusive privileges
to produce or sell any particular product, they can't say only three guys can produce
salt or whatever, so this is for good reason why most of the people are against monopoly
and then what these people, the economists did was they changed the definition of the
term monopoly to mean not grant a privilege by the government but facing a falling demand
curve which everybody faces, it means everybody is an evil monopolist you see and this changes
is the whole meaning of the discussion.
Competition became not competing for products
or making better products or making it cheaper or whatever.
Competition meant a horizontal man curve.
It meant not being able to affect your price
regardless of how much production you make.
It's very weird, and yet this conquer
of the economics profession, at the same time
when Keynesianism and macroeconomics also conquered it,
and it took about 50 years to get rid of Keynesianism
or to roll it back, it's taken about the same amount
of time to roll back the perfect competition doctrine.
It's been rolled back a lot in the last fifty years, but not enough, of course.
Anyway, I'll now hand out the papers, the exams,
shift to that.
You all did spectacularly well, almost too well.