Micro Ch 21 Presentation 2
Profit Maximization in the SR
• Because the purely competitive firm is a price taker, it can maximize its economic profit/minimize loss only by adjusting its output.
• With a fixed plant, the firm can only adjust its output through changes in the amount of variable resources it uses (materials, labor)
Methods to Determine Output
• 1. compare total revenue and total cost• 2. compare marginal revenue and marginal
cost• *both methods apply to all firms whether
pure competition, pure monopolies, monopolistic competition or oligopolies
1. Total Revenue-Total Cost Approach
• The firm must ask three questions:• 1. Should we produce the product?• 2. If so, how much?• 3. What economic profit (or loss) will we
realize?
Total Revenue Total Cost Approach
(1)Total Product(Output) (Q)
(2)Total FixedCost (TFC)
(3)Total Variable
Cost (TVC)
(4)Total Cost
(TC)
(5)Total Revenue
(TR)
(6)Profit (+)or Loss (-)
Price = $131
0123456789
10
$100100100100100100100100100100100
$090
170240300370450540650780930
$100190270340400470550640750880
1030
$0131262393524655786917
104811791310
$-100-59
-8+53
+124+185+236+277+298+299+280
Now Let’s Graph The Results…Do You See Profit Maximization?
Break Even Point
• Point(s) where total revenue and total cost are equal
• Total revenue covers all costs including a normal profit but not an economic profit
• **the firm achieves maximum profit where the vertical distance between the TR and TC curves is greatest
Total Revenue-Total Cost Approach
Profit Maximization in the Short Run
10 2 3 4 5 6 7 8 9 10 11 12 13 14
10 2 3 4 5 6 7 8 9 10 11 12 13 14
$180017001600150014001300120011001000
900800700600500400300200100
$500400300200100
Tota
l Rev
enue
and
Tot
al C
ost
Tota
l Eco
nom
icPr
ofit
Quantity Demanded (Sold)
Quantity Demanded (Sold)
Total Revenue, (TR)
Break-Even Point(Normal Profit)
Break-Even Point(Normal Profit)
MaximumEconomic
Profit$299
Total EconomicProfit
$299
P=$131
Total Cost,(TC)
W 21.1
G 21.1
2. Marginal Revenue-Marginal Cost Approach
• Compare the amounts that each additional unit of output would add to TR and TC
• The firm should produce any unit of output whose MR > or = MC
MR = MC Considerations
• Most often, MR = MC at a fractional amount of output---- the firm should complete the last complete unit of output where MR > MC
• Can be restated Price = MC for perfectly competitive market
• ****Rule applies only if MR is = or > AVC
Calculating Economic Profit
• Profit = (price – ATC) x Q• Per Unit Profit = price - ATC
Cost
and
Rev
enue
$200
150
100
50
01 2 3 4 5 6 7 8 9 10
Output
Economic Profit
Profit Maximization in the Short Run
MR = P
MCMR = MC
AVC
ATC
P=$131
A=$97.78
W 21.2
Loss Minimizing Case
The firm should produce at a loss @ MR = MC where price is greater than AVC but less than ATC
The loss must be less than the TFC
Lower the Price to $81 andObserve the Results!
Co
st a
nd
Rev
enu
e$200
150
100
50
01 2 3 4 5 6 7 8 9 10
Output
Loss
Marginal Revenue-Marginal Cost ApproachMR = MC Rule
Profit Maximization in the Short Run
MR = P
MC
AVCATC
Loss Minimizing Case
P=$81
V = $75
Shut Down Case
• A firm will Shut down at a price where Price is less than AVC
Lower the Price Further to $71 and Observe the Results!
Cost
and
Rev
enue
$200
150
100
50
01 2 3 4 5 6 7 8 9 10
Output
Marginal Revenue-Marginal Cost ApproachMR = MC Rule
Profit Maximization in the Short Run
MR = P
MC
AVC
ATC
Short-Run Shut Down Case
P=$71 Short-Run Shut Down Point
P < Minimum AVC$71 < $74
V = $74
Marginal Cost and Short-Run Supply
Generalizing the MR=MC Relationship and its Use
P1
0
Co
st a
nd
Rev
enu
es (
Do
llars
)
Quantity Supplied
MR1
P2 MR2
P3 MR3
P4 MR4
P5 MR5
MC
AVC
ATC
Q2 Q3 Q4 Q5
This Price is Below AVCAnd Will Not Be Produced
ab
c
d
e
MC Above AVC Becomesthe Short-Run Supply Curve S
Examine the MC for the Competitive Firm
Break-even(Normal Profit) Point
Shut-Down Point (If P is Below)
Single Firm MarketP
rice
Pri
ce
Quantity Quantity
0 0
Long-Run EquilibriumCompetitive Firm and Market
P MR
D
S
QeQf
ATC
Productive Efficiency: Price = Minimum ATCAllocative Efficiency: Price = MCPure Competition Has Both in
Its Long-Run Equilibrium
MCP=MC=MinimumATC (Normal Profit)
P