1. Micro Ch 21 Presentation 2

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)

3. 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

4. 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?

5. Total Revenue Total Cost Approach (1) Total Product (Output) (Q) (2) Total Fixed Cost (TFC) (3) Total Variable Cost (TVC) (4) Total Cost (TC) (5) Total Revenue (TR) (6) Profit (+) or Loss (-) Price = $131 0 1 2 3 4 5 6 7 8 9 10 $100 100 $0 90 170 240 300 370 450 540 650 780 930 $100 190 270 340 400 470 550 640 750 880 1030 $0 131 262 393 524 655 786 917 1048 1179 1310 $-100 -59 -8 +53 +124 +185 +236 +277 +298 +299 +280 Now Let’s Graph The Results… Do You See Profit Maximization?

6. 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

7. Total Revenue-Total Cost Approach Profit Maximization in the Short Run 10234567891011121314 10234567891011121314 $1800 1700 1600 1500 1400 1300 1200 1100 1000 900 800 700 600 500 400 300 200 100 $500 400 300 200 100 Total Revenue and Total Cost Total Economic Profit Quantity Demanded (Sold) Total Revenue, (TR) Break-Even Point (Normal Profit) Break-Even Point (Normal Profit) Maximum Economic Profit $299 Total Economic Profit $299 P=$131 Total Cost, (TC) W 21.1 G 21.1

8. 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

9. 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

10. Calculating Economic Profit Profit = (price – ATC) x Q Per Unit Profit = price - ATC

11. Cost and Revenue $200 150 100 50 0 12345678910 Output Economic Profit Profit Maximization in the Short Run MR = P MC MR = MC AVC ATC P=$131 A=$97.78 W 21.2

12. 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

13. Lower the Price to $81 and Observe the Results! Cost and Revenue $200 150 100 50 0 12345678910 Output Loss Marginal Revenue-Marginal Cost Approach MR = MC Rule Profit Maximization in the Short Run MR = P MC AVC ATC Loss Minimizing Case P=$81 V = $75

14. Shut Down Case A firm will Shut down at a price where Price is less than AVC

15. Lower the Price Further to $71 and Observe the Results! Cost and Revenue $200 150 100 50 0 12345678910 Output Marginal Revenue-Marginal Cost Approach MR = 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

16. Marginal Cost and Short-Run Supply Generalizing the MR=MC Relationship and its Use P1P1 0 Cost and Revenues (Dollars) Quantity Supplied MR 1 P2P2 MR 2 P3P3 MR 3 P4P4 MR 4 P5P5 MR 5 MC AVC ATC Q2Q2 Q3Q3 Q4Q4 Q5Q5 This Price is Below AVC And Will Not Be Produced a b c d e MC Above AVC Becomes the Short-Run Supply Curve S Examine the MC for the Competitive Firm Break-even (Normal Profit) Point Shut-Down Point (If P is Below)

17. Single FirmMarket Price Quantity 0 0 Long-Run Equilibrium Competitive Firm and Market P MR D S QeQe QfQf ATC Productive Efficiency: Price = Minimum ATC Allocative Efficiency: Price = MC Pure Competition Has Both in Its Long-Run Equilibrium MC P=MC=Minimum ATC (Normal Profit) P