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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)
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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
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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?
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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?
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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
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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
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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
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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
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Calculating Economic Profit
• Profit = (price – ATC) x Q• Per Unit Profit = price - ATC
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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
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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
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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
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Shut Down Case
• A firm will Shut down at a price where Price is less than AVC
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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
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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)
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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