Chapter 8. Profit Maximization and Competitive Supply

Chapter 8. Profit Maximization and Competitive Supply

Topics to be Discussed

n  Profit Maximization

n  Marginal Revenue, Marginal Cost, and Profit Maximization

n  Choosing Output in the Short Run / Long Run

n  Perfectly Competitive Markets

Introduction

n  Characteristics of Perfectly Competitive Markets

1) Identical products

2) Individual firms are too small to impact the market

3)  No barriers to entry and exit

Marginal Revenue, Marginal Cost, and Profit Maximization

n  Determining the profit maximizing level of output

•  Profit = Total Revenue - Total Cost

•  Total Revenue (R) = Pq

•  Total Cost (C) = Cq

Profit Maximization in the Short Run

Marginal Revenue, Marginal Cost, and Profit Maximization

n  Observations

R(q)

–  R(q) slope = marginal revenue

C(q)

–  C(q) slope = marginal cost

n  Marginal revenue is the additional revenue from producing one more unit of output.

n  Marginal cost is the additional cost from producing one more unit of output.

n  Comparing R(q) and C(q)

–  MR > MC

•  Indicates higher profit at higher output

Marginal Revenue, Marginal Cost, and Profit Maximization

n  Comparing R(q) and C(q)

•  Output levels

–  MR = MC

n  Therefore, it can be said:

Profits are maximized when MC = MR.

n  The Competitive Firm : Price Taker

A) The competitive firm’s demand

–  Individual producer sells all units for $4 regardless of the producer’s level of output.

–  If the producer tries to raise price, sales are zero.

–  If the producers tries to lower price he cannot increase sales

–  P = D = MR = AR

B) The competitive firm’s Profit Maximization

–  MC(q) = MR = P

n  Summary of Production Decisions

5. A competitive firm’s short run supply curve is MC above AVC

The Short-Run Market Supply Curve

n  Producer Surplus in the Short Run

•  Firms earn a surplus on all but the last unit of output.

•  The producer surplus is the sum over all units produced of the difference between the market price of the good and the marginal cost of production.

•  The consumer surplus is the sum over all units produced of the difference between the market price of the good and the marginal cost of production.

• 

SKIP From LR Competitive Equilibrium on page 272.

READ the textbook from page 288 to page 292.

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