Economic Optimization1

Economic Optimization
Details of Topics
Economic optimization process

Basic economic relations
Marginals as the derivatives of functions
Rules for differentiating a function.
Multivariate optimization and the Lagrangian
Technique
Constrained & Un-constrained optimization
Marginal analysis in decision making
Incremental concept in economic analysis.
Rules for Differentiating a Function
Powers:
Sums and Differences
Products
Quotients
Logarithmic Functions
Chain Rule
Partial derivatives
Economic Optimization Process

Process of arriving at the best solution to a
problem.
Optimal Decision
Best decision produces the result most
consistent with managerial objectives.
Maximizing the Value of the Firm

Produce what customers want.
Meet customer needs efficiently.
Value of firm=?
Economic Optimization Process

We deal with two types of economic
optimization.
I. Unconstraint Economic Optimization.
i. Univariate
ii. Multivariate
II. Constraint Economic Optimization.
Revenue Relations
Spreadsheet?
Equation
expression of functional relationship.
Price and Total Revenue

Total Revenue = f(Q)
Total Revenue = Price Quantity.
TR = P Q
Linear Demand Curve

P=a+bQ
Revenue and Price Relations

Q
24.00
22.50
21.00
19.50
18.00
16.50
15.00
13.50
12.00
10.50
10
9.00
TR
MR
Revenue Relations
Marginal Revenue
Change in total revenue associated with a one-unit
change in output.
Revenue Maximization
Quantity with highest revenue, MR = 0.
Revenue and Price Relations

Q
TR
MR
24.00
0.00
--
22.50
22.50
22.50
21.00
42.00
19.50
19.50
58.50
16.50
18.00
72.00
13.50
16.50
82.50
10.50
15.00
90.00
7.50
13.50
94.50
4.50
12.00
96.00
1.50
10.50
94.50
-1.50
10
9.00
90.00
-4.50
Maximize/ Minimize Relation

TR= $24Q $1.5Q2
Cost Relations
Total Cost
Marginal Cost
Average Cost
Fixed Cost
Variable Cost
Cost Relations
Short-run vs. Long-run Funtctions
Total Cost
Total Cost = Fixed Cost + Variable Cost.
Marginal Cost
Marginal cost is the change in total cost associated
with a one-unit change in output.
Average Cost
Average Cost = Total Cost/Quantity
Average Cost Minimization

Average cost is minimized when MC = AC.
Reflects efficient production of a given output level.
Cost Output Relations

Q
FC
VC
8.00
0.00
8.00
4.50
8.00
10.00
8.00
16.50
8.00
24.00
8.00
32.50
8.00
42.00
8.00
52.50
8.00
64.00
8.00
76.50
10
8.00
90.00
TC
MC
AC
Cost Output Relations

Q
FC
VC
TC
MC
AC
8.00
0.00
8.00
--
--
8.00
4.50
12.50
4.50
12.50
8.00
10.00
18.00
5.50
9.00
8.00
16.50
24.50
6.50
8.17
8.00
24.00
32.00
7.50
8.00
8.00
32.50
40.50
8.50
8.10
8.00
42.00
50.00
9.50
8.33
8.00
52.50
60.50
10.50
8.64
8.00
64.00
72.00
11.50
9.00
8.00
76.50
84.50
12.50
9.39
10
8.00
90.00
98.00
13.50
9.80
Goal is to minimize costs

A business can find the quantity where
costs are minimized by going to the point
where MC = AC The typical cost curve.
2009, 2006 South-Western, a

part of Cengage Learning
Maximize/ Minimize Relation

TC = $8 + 4Q + .5Q2
Profit Relations
Total and Marginal Profit
Total Profit ( ) = Total Revenue - Total Cost.
Marginal profit is the change in total profit due to a
one-unit change in output, M = MR - MC.
Profit Maximization
Profit is maximized when M = MR MC = 0 or MR
= MC, assuming profit declines as Q rises.
Quantity, Revenue, Cost and Profit relations

Q
FC
VC
8.00
0.00
24.00
8.00
4.50
22.50
8.00
10.00 21.00
8.00
16.50 19.50
8.00
24.00 18.00
8.00
32.50 16.50
8.00
42.00 15.00
8.00
52.50 13.50
8.00
64.00 12.00
8.00
76.50 10.50
10
8.00
90.00
9.00
TR
MR
TC
MC
AC
Pr.
M.Pr.
Quantity, Revenue, Cost and Profit relations

Q
FC
VC
TR
MR
TC
MC
AC
Pr.
M.Pr.
8.00
0.00
24.00
0.00
--
8.00
--
--
-8
--
8.00
4.50
22.50 22.50 22.50 12.50
4.50
12.50
10
18
8.00
10.00 21.00 42.00 19.50 18.00
5.50
9.00
24
14
8.00
16.50 19.50 58.50 16.50 24.50
6.50
8.17
34
10
8.00
24.00 18.00 72.00 13.50 32.00
7.50
8.00
40
8.00
32.50 16.50 82.50 10.50 40.50
8.50
8.10
42
8.00
42.00 15.00 90.00
7.50
50.00
9.50
8.33
40
-2
8.00
52.50 13.50 94.50
-4.50
60.50 10.50
8.64
34
-6
8.00
64.00 12.00 96.00
-1.50
72.00 11.50
9.00
24
-10
8.00
76.50 10.50 94.50
-1.50
84.50 12.50
9.39
10
-14
10
8.00
90.00
-4.50
98.00 13.50
9.80
-8
-18
9.00
90.00
Marginal v. Incremental Profits

Marginal v. Incremental Profits
Marginal profit is the gain from producing one more
unit of output (Q).
Incremental profit is gain tied to a managerial
decision, possibly involving multiple units of Q.
For example: new product line, change in production
system, 20% increase in product.

Economic Optimization1

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Economic Optimization

Economic optimization process

Rules for Differentiating a Function

Economic Optimization Process

Maximizing the Value of the Firm

Economic Optimization Process

II. Constraint Economic Optimization.

Price and Total Revenue

Linear Demand Curve

Revenue and Price Relations

Revenue and Price Relations

Maximize/ Minimize Relation

Average Cost Minimization

Cost Output Relations

Cost Output Relations

Goal is to minimize costs

2009, 2006 South-Western, a

Maximize/ Minimize Relation

Quantity, Revenue, Cost and Profit relations

Quantity, Revenue, Cost and Profit relations

22.50 22.50 22.50 12.50

10.00 21.00 42.00 19.50 18.00

16.50 19.50 58.50 16.50 24.50

24.00 18.00 72.00 13.50 32.00

32.50 16.50 82.50 10.50 40.50

42.00 15.00 90.00

52.50 13.50 94.50

64.00 12.00 96.00

76.50 10.50 94.50

Marginal v. Incremental Profits

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