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Perfect

CompetitionChapter 14-2.

Profit Maximizing andProfit Maximizing and

Shutting DownShutting Down

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Profit-Maximizing Level ofOutput The goal of the firm is to maximize

profits. Profit is the difference between total

revene and total cost.

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Profit-Maximizing Level ofOutput !hat happens to profit in response to a

change in otpt is determined b"marginal revene #MR$ and marginalcost #MC$.

% firm maximizes profit when MC& MR.

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Profit-Maximizing Level ofOutput Marginal revenue#MR$ ' the change

in total revene associated with achange in (antit".

Marginal cost#MC$ ' the change in totalcost associated with a change in (antit".

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Marginal Revenue

% perfect competitor accepts the

mar)et price as given. %s a reslt* marginal revene e(als

price #MR = P$.

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Marginal Cost

+nitiall"* marginal cost falls and then

begins to rise. ,arginal concepts are best defined

between the nmbers.

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Profit Maximization: MC = MR

To maximize profits* a firm shold

prodce where marginal cost e(alsmarginal revene.

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How to Maximize Profit

+f marginal revene does not e(al

marginal cost* a firm can increase profitb" changing otpt.

The spplier will contine to prodce as

long as marginal cost is less thanmarginal revene.

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How to Maximize Profit

The spplier will ct bac) on prodction

if marginal cost is greater than marginalrevene.

Ths* the profit-maximizing condition of a

competitive firm is MC = MR = P.

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Again MR=MC

Profit is maximized when ,&,C.

' +f the cost of prodcing one more nit islessthan the revene it generates* then aprofit is available for the firm thatincreases prodction b" one nit.

' +f the cost of prodcing one more nit ismorethan the revene it generates* thenincreasing prodction redces profit.

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C

%P = D = MR

Costs

1 2 3 4 5 6 7 8 9 10 Quantity

60

5040

30

2010

0

A

B

MC

Marginal Cost! Marginal

Revenue! an" Price

12/403

1

523.2.1.14.12.1.

22./.4.04.3.

Price = MR Quantity

Produced

Marginal

Cost

5/0.

/0./0./0./0./0./0./0./0./0./0.

McGraw-Hill/Irwin 2004 The McGraw-Hill Companies, Inc., AllRi hs Reser!e".

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Profit Maximization:

#rap$ical Anal%sis

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Profit Maximization: &$e

'um(ers

6 P T TC T-TC , ,C %TC

0 $1 $0 $1.00 -$1.00 $1

1 $1 $1 $2.00 -$1.00 $1 $1.00 $2.00

2 $1 $2 $2.80 -$0.80 $1 $0.80 $1.40

$1 $ $.!0 -$0.!0 $1 $0."0 $1.1"4 $1 $4 $4.00 $0.00 $1 $0.!0 $1.00

! $1 $! $4.!0 $0.!0 $1 $0.!0 $0.#0

$1 $ $!.20 $0.80 $1 $0."0 $0.8"

" $1 $" $.00 $1.00 $1 $0.80 $0.8

8 $1 $8 $.8 $1.14 $1 $0.8 $0.8

51 5 5.3 51.14 51 51. 5.3

10 $1 $10 $#. $0.4 $1 $1.!0 $0.#4

11 $1 $11 $12.00 -$1.00 $1 $2.4 $1.0#

M%&M'M%&M'

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&$e Marginal Cost Curve)s t$e *uppl% Curve The marginal cost crve is the firm7s

sppl" crve above the point whereprice exceeds average variable cost.

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&$e Marginal Cost Curve)s t$e *uppl% Curve The ,C crve tells the competitive firm

how mch it shold prodce at a givenprice.

The firm can do no better than prodce

the (antit" at which marginal cost e(alsmarginal revene which in trn e(alsprice.

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&$e Marginal Cost Curve )st$e +irm,s *uppl% Curve

A

B

C,arginal cost

C

ost*Price

5

0

4

/

2

1

1 6antit"2 / 4 0 3 1

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+irms Maximize &otalProfit 8irms see) to maximize total profit* not

profit per nit.' 8irms do not care abot profit per nit.

'%s long as increasing otpt increasestotal profits* a profit-maximizing firmshold prodce more.

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Profit Maximization sing&otal Revenue an" &otal Cost Profit is maximized where the vertical

distance between total revene andtotal cost is greatest.

%t that otpt* MR#the slope of the

total revene crve$ andMC

#the slopeof the total cost crve$ are e(al.

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TC TR

Tot

alcost*reve

ne

5/30/0

/102324021101410

/0

6antit"1 2 / 4 0 3

Profit .etermination sing &otal

Cost an" Revenue Curves

,aximm profit &531

51/

9oss

9oss

Profit

Profit &540


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&otal Profit at t$e Profit-Maximizing Level of Output The P = MR = MCcondition tells s

how mch otpt a competitive firmshold prodce to maximize profit.

+t does not tell s how mch profit the

firm ma)es.

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.etermining Profit an" Loss+rom a &a(le of Costs Profit can be calclated from a table of

costs and revenes. Profit is determined b" total revene

mins total cost.

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Costs Relevant to a +irm


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Costs Relevant to a +irm


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.etermining Profit an"Loss +rom a #rap$ 8ind otpt where MC = MR.

' The intersection of MC = MR#P$determines the (antit" the firm willprodce if it wishes to maximize profits.

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.etermining Profit an"Loss +rom a #rap$ 8ind profit per nit where ,C & ,.

' :rop a line down from where ,C e(als ,*and then to the %TC crve.

' This is the profit per nit.

' ;xtend a line bac) to the vertical axis toidentif" total profit.

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.etermining Profit an"Loss +rom a #rap$ The firm ma)es a profit when the %TC

crve is below the , crve.

The firm incrs a loss when the %TC crveis above the , crve.

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.etermining Profit an" Loss+rom a #rap$

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(a Pro!it case (" #ero $ro!it case (c %oss case

.etermining Profits #rap$icall%

Quantity Quantity Quantity

Price

65605550

454035302520

151050

65605550

454035302520

151050

1 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12

D

MC

A P = MR

B ATC

AVCE

Pro!it

C

MC

ATC

AVC

MC

ATC

AVC

%oss

65605550

454035302520

151050

1 2 3 4 5 6 7 8 910 12

P = MR

P = MR

Price Price

The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill

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Loss Minimization

()erage *ost of a unit of out+ut()erage *ost of a unit of out+ut

%e)enue%e)enue

generated , agenerated , a

unit of out+utunit of out+ut

MaretMaret

+ri*e+ri*e

fallsfalls

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&$e *$ut"own Point

The firm will sht down if it cannot cover

average variable costs.'% firm shold contine to prodce as longas price is greater than average variablecost.

' +f price falls below that point it ma)essense to sht down temporaril" and savethe variable costs.

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&$e *$ut"own Point

The shutdown pointis the point at

which the firm will be better off it itshts down than it will if it sta"s inbsiness.

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&$e *$ut"own Point

+f total revene is more than total

variable cost* the firm=s best strateg" isto temporaril" prodce at a loss.

+t is ta)ing less of a loss than it wold b"shtting down.

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MC

P = MR

2 4 3 6antit"

Price

0

4

/

2

1

ATC

AVC

9oss

A51.3

&$e *$ut"own .ecision

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Minimizing Loss

Shutdown +ri*e/the minimm point of the

average-variable-cost #%>C$ crve.

rea-e)en +ri*e/% price that is e(al to

the minimm point of the average-total-cost #%TC$ crve.'%t this price* economic profit is zero.

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Profit Maximizing Level of

Output

Marginal re)enue M%is the change in totalrevene associated with a change in (antit"

% firm maximizes profit when marginal revene e(als

marginal cost

The goal of the firm is to maximize profits* the differencebetween total revene and total cost

Marginal *ost M' is the change in total cost associatedwith a change in (antit"

14-35

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Profit Maximizing Level of

Output

+f MR < MC*

a firm can increase profit b" decreasing its otpt

+f MR > MC*

a firm can increase profit b" increasing otpt

The profit-maximizing condition of a competitive firm is?

M% & M'

8or a competitive firm* M% & P

% firm maximizes total profit* not profit per nit

14-36

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Marginal Cost! Marginal

Revenue! an" Price #rap$P

3

Marginal'ost

$! P & D & M%

M' P5in*rease out+ut to

in*rease total +rofit

M' & P at 8 units5total +rofit ismaximized

M' 6 P5de*rease out+ut to

in*rease total +rofit

M' & P

14-37

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&$e Marginal Cost Curve is

t$e *uppl% Curve

@ecase the marginal costcrve tells s how mch ofa good a firm will sppl" at

a given price* themarginal *ost *ur)e is the

firm7s su++l *ur)e

PMarginal

'ost

$!

3

$1#.!0

$1

8 10

irm7s Su++l'ur)e&

14-38

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Profit Maximization using &otal

Revenue an" &otal Cost

Total cost is the cmlative sm of themarginal costs* pls the fixed costs

%n alternative method to determine the profit-maximizinglevel of otpt is to loo) at the total and total cost crves

Total profit is the difference between totalrevene and total cost crves

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&otal Revenue an" &otal

Cost &a(le9otal 'ost59otal %e)enue 9'

$1"!

3

$10

$280

8!

9%The total revene crve

is a straight line

The total cost crve isbowed pward at most

(antities reflectingincreasing marginal cost

,ax profit & 531at 3 nits of

otpt

9osses 9ossesProfits

Profits are maximizedwhen the verticaldistance between Tand TC is greatest

14-40

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.etermining Profits #rap$icall%:

A +irm wit$ Profit

(:'

M'

3

P

(9'

8ind otpt where,C & ,* this is theprofit maximizing 6

P & D & M%

M' & M%

3+rofit max

8ind profit per nitwhere the profit max 6

intersects %TC

(9' at 3+rofit max

P

(9'

Profits

Sin*e P6(9' at the+rofit maximizing ;uantit5this firm is earning +rofits

14-41

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A +irm wit$ /ero Profit or Losses

(:'

M'

3

P

(9'M' & M%

3+rofit max

(9' at 3+rofit max

P&(9'

P & D & M%

Sin*e P&(9' at the+rofit maximizing ;uantit5

this firm is earningzero +rofit or loss



intersects %TC

14-42

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A +irm wit$ Losses

(:'

M'

3

P

(9'

M' & M%

3+rofit max

(9' at 3+rofit max

P

(9' P & D & M%

Sin*e P(9' at the

+rofit maximizing ;uantit5this firm is earning losses



intersects %TC

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&$e *$ut"own .ecision

(:'

M'

3

P

(9'

3+rofit max

PShutdown P & D & M%

The shtdown point is thepoint below which the firmwill be better off if it shtsdown than it will if it sta"s

in bsiness +f PAmin of %>C* then the

firm will still prodce* btearn a loss

+f PBmin of %>C* the firmwill sht down

+f a firm shts down* it stillhas to pa" its fixed costs

14-44

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*$ort-Run Mar0et *uppl%

an" .eman"

The mar)et #indstr"$ sppl" crve is the horizontalsm of all the firms= marginal cost crves

!hile the firm=s demand crve is perfectl" elastic*the indstr"=s demand crve is downward sloping

The mar)et sppl" crve ta)es into accont an"changes in inpt prices that might occr

14-45

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(9'Profits

*$ort-Run Mar0et *uppl% an"

.eman" #rap$P

3

MaretSu++l

P

MaretDemand

P

3

P P & D & M%

M'

(9'

3+rofit max

,ar)et 8irm

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