Lecture on Profit Maximizing Rule in Economics

Key Example: Brian's Bread Baking Company

• Fixed Capital: Limited number of ovens.
• Marginal Cost: Cost of producing more bread increases with more production.
• Selling Price: Bread sells for $0.70 per loaf.

Baker Hiring Decision

• 1st Baker:
  • Produces 30 loaves/hour.
  • Cost: $15/hour.
  • Marginal cost per loaf: $0.50.
  • Profit: $0.70 - $0.50 = $0.20 per loaf. Profitable.
• 2nd Baker:
  • Produces 25 loaves/hour (due to diminishing returns).
  • Marginal cost per loaf: $0.60.
  • Profit: $0.70 - $0.60 = $0.10 per loaf. Profitable.
• 3rd Baker:
  • Produces 20 loaves/hour.
  • Marginal cost per loaf: $0.75.
  • Profit: $0.70 - $0.75 = -$0.05 per loaf. Not profitable.

Profit Maximizing Rule

• Definition: Produce until marginal cost (MC) equals marginal revenue (MR).
• MR: Money earned by selling one more unit; usually the market price in a competitive market.
• MC: Cost of producing one more unit, increases with quantity.
• Goal: Continue to produce until MC = MR.

Example: Oil Production

• Market Price: Determines the price for oil sold.
• Marginal Revenue: Set by market price for each barrel.
• Marginal Cost: Increases as oil is extracted from deeper sources (e.g., ocean floor).
• Decision Point: Only extract oil until MC meets the market price (MR).

Bread Baking Business Analysis

• Initial Investment: Ovens, equipment, staff, and personal effort.
• Decision Focus: Only on marginal costs of next unit, not fixed costs.
• Sales Price: $1 per loaf.
• Marginal Cost (MC):
  • First loaf: $0.10
  • Profit: $1 - $0.10 = $0.90. Profitable.
• Process:
  • MR remains constant ($1).
  • MC increases over time (e.g., diminishing returns).
  • Continue producing as long as MR > MC.

Key Point

• Profit Maximizing Quantity: Where MR = MC.
• Decision Rule: Stop production when MC exceeds MR.

Summary

• MR > MC: Increase production.
• MC = MR: Optimal production point.
• MC > MR: Stop production.

This rule helps firms determine the optimal level of output to maximize profit by balancing the additional revenue garnered from selling one more unit against the cost of producing that unit.