chapter 9 Profit Maximization Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Chapter 9 Profit Maximization Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent.
Dec 21, 2015
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chapter 9
Profit Maximization
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
9-2
Learning Objectives
• Describe the relationship between a firm’s marginal revenue and its price.
• Explain how firms should determine their profit-maximizing sales quantities.
• Identify the profit-maximizing sales quantity for a price-taking firm, and derive its supply function.
• Explain why price-taking firms usually respond to price changes more over the long run than they do over the short-run.
• Define producer surplus and describe its measurement.
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
9-3
Overview
• Firm managers usually set their prices (or sales quantities) to maximize profits
• To find those optimal prices (or quantities) we will use marginal revenue and marginal cost
• In competitive markets firms take the market price for their product as given, and decide on profit-maximizing sales quantities
• Producer surplus is a measure of profits that focuses on avoidable costs
• Profit maximization techniques also work for multiproduct price-taking firms
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Choosing Price versus Choosing Quantity
Inverse demand function: how much the firm must charge to sell any given quantity of its product
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9-5
Maximizing Profit
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9-6
Profit-Maximizing Quantity and Price
Profit-maximizing priceCopyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Profit-Maximizing Sales Quantity
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9-8
Marginal Revenue, Marginal Cost, and Profit Maximization
• Marginal revenue: additional revenue produced by the ΔQ marginal units sold, on a per unit basis.
• Inframarginal units: units firm sells other than the ΔQ marginal units
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9-9
Marginal Revenue
• Increase in sales quantity, from Q – ΔQ to Q changes revenue in two ways• Output expansion effect:
sell ΔQ additional units, each at price of P(Q)
• Price reduction effect: increased sales quantity requires a reduction in price from P(Q – ΔQ) to P(Q)
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Marginal Revenue and Price
Output expansion effect
Price reduction effect Output
expansion effect
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9-11
Marginal Revenue and Demand Curves
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9-12
Finding Profit-Maximizing Sales Quantity using Marginal Revenue and Marginal Cost
• Step 1: Quantity rule. Identify positive sales quantities where MR = MC. If it is satisfied by more than one positive sale then determine with produces the highest profit.
• Step 2: Shut-down rule. Check whether the most profitable positive sale quantity results in greater profit than shutting down.
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
9-13
Finding Profit-Maximizing Sales Quantity for Price-Taking Firms
• Step 1: Quantity rule. For a price-taking firm, P = MR for all quantities. Identify positive sales quantities where P = MC. If it is satisfied by more than one positive sale then determine with produces the highest profit.
• Step 2: Shut-down rule. Check whether the most profitable positive sale quantity results in greater profit than shutting down.
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Profit-Maximizing Sales for Price-Taking Firm - No Sunk Costs
P > ACElse, shut down
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9-15
Supply Function of a Price-Taking Firm
•
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Supply Curve of a Price-Taking Firm
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Law of Supply• When market price
increases, the profit-maximizing sales quantity for a price-taking firm never decreases
• In the graph, when the market price rises, revenue rises more quantity Ǭ than at any smaller quantity
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9-18
Increase in Marginal Cost
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9-19
Increase in Avoidable Fixed Cost
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9-20
Short-Run Versus Long-Run Supply
• Firm’s marginal and average costs may differ in the long and short run because some inputs are fixed rather than variable in the short run
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SR and LR Responses to a Price Increase
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Producer Surplus
• Producer Surplus = revenue - avoidable cost
• Profit = producer surplus – sunk cost Producer
surplus
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• Producer Surplus = revenue - avoidable cost
• Profit = producer surplus – sunk cost Producer
surplus
Producer Surplus
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9-24
Supply by Multiproduct Price-Taking Firms
• Finding profit-maximizing sales quantities and prices for two products
• Quantity rule: find most profitable pair of positive sales quantities at which price equals marginal cost for both products
• Shut-down rule: compares the profit from those quantities with:a) Shutting down first product while selling secondb) Shutting down second product while selling firstc) Shutting down both products
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
9-25
Review
• The relationship between a firm’s price and sales quantity is described by the demand curve for its product.
• The quantity rule + the shut-down rule identify the firm’s profit-maximizing sales quantity
• The law of supply tells us that a competitive firm’s supply never decreases when the market price increases.
• A firm’s producer surplus equals its revenue less its avoidable costs. Therefore, the firm’s profit equals its producer surplus less its sunk costs.
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9-26
Looking Forward
• Next we will switch our focus to how consumers and firms make intertemporal decisions.
• The tools we have learned will still be useful, but we will need to learn a few more concepts, the interest rate and the present discounted value among them.
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