Economic Optimization

Optimal decision- the choice

alternative that produces a
result most consistent with
managerial objectives, which we
presume is profit maximization.

Steps in the Decision

Process
1.

2.

Economic relations must be

expressed in a form suitable for
analysis; the managerial
decision problem must be
expressed in analytical terms.
Optimization techniques must
be applied to determine the
best, or optimal, solution in
light of managerial objectives.

Maximizing the Value of the

Firm

The value of the firm is

impacted by

Total Revenue.... which is a

function of marketing strategies,
pricing and distribution policies,
nature of competition....
Total Cost .... which is a function
of the price and availability of
inputs, alternative production
methods...

Basic Economic Relations

Outline
Functional Relations:
Equations
Total, Average, and Marginal
Relations
Graphing Total, Average, and
Marginal Relations

Functional Relations:
Equations
Definitions

Equations Analytical representation

of functional relationships.
Dependent Variable The variable on
the left side of the equation...the yvariable...the variable whose value is
dependent upon changes in the xvariables...the endogenous variable.
Independent Variable The variables
on the right side of the equation...the
x-variables...the variables who
determine the value of the yvariable...the exogenous variable.

Functional Relations:
Equations
More Definitions

Endogenous variable A factor

that is determined by the
independent variables in the
model.
Exogenous variables A factor
determined outside the model,
yet impacts the dependent
variable in the model.

Functional Relations:
Equations
TR = f(Q)
In words....
Total Revenue is a function of
output.
1.
What is endogenous?
2.
What is exogenous?
3.
Are there other variables that will
impact total revenue?

Total, Average, and Marginal

Relations
Definitions

Marginal change in a dependent

variable caused by a one unit change
in an independent variable.
A Marginal Change is represented as

/ X

Alternative definitions:
Rate of change
Slope

Examples of Marginal
Relationships

Marginal Revenue change in total

revenue associated with a one-unit
change in output.
Marginal Cost Change in total cost
associated with a one-unit change in
output.
Marginal Profit Change in profit
associated with a one-unit change in
output.

Examples of Average
Relationships

Average Revenue = Total

Revenue/Output
What is another name for average
revenue?
Average Cost = Total Cost/Output
Average Fixed Cost = TFC / Q
Average Variable Cost = TVC/Q
Average Profit = Total Profit/ Output

Graphing Total, Marginal, and

Average Relations

Slope a measure of the steepness of

a line.
OR

Tangent a line that touches but does

not intersect a given curve.

The rate of change

The marginal relation

This is used to find the slope of a

nonlinear curve.

Inflection Point a point of maximum

slope.