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The profit maximising position

Neo-classical Theory of the Firm. The profit maximising position. The assumptions of the model:. 1. All the goods in the market are homogenous. 2. There are many buyers and many sellers. 3. There is perfect information – buyers and sellers know everything and information is symmetric.

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The profit maximising position

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  1. Neo-classical Theory of the Firm The profit maximising position

  2. The assumptions of the model: • 1. All the goods in the market are homogenous. • 2. There are many buyers and many sellers. • 3. There is perfect information – buyers and sellers know everything and information is symmetric. • 4. There are no barriers to entry or exit in the market. • 5. There are no transport costs.

  3. On graph paper plot the demand curve, MR and MC curves and find the profit maximising position.

  4. D = AR = MR

  5. Profit Maximisation occurs at the level of output where MC=MR

  6. The neo-classical theory f the firm Perfect Competition

  7. Market Firm X MC P P AC S1 P1 D=AR=MR D1 Qd Q1 Qd

  8. Supernormal profit/Abnormal profit • Normal profit is equal to the opportunity cost of being in that business • Eg. A businessman earns £30,000 profit per annum running a coffee bar • Next best alternative is running a dry cleaners • The benefit foregone from the next best alternative is for £28,000 a year • Normal profit = £28,000 • Supernormal profit = £2,000 (everything above the normal profit • Normal profit is therefore included as a cost in average and variable cost curves.

  9. Because there is supernormal profit and perfect information – this attracts new entrants into the market Market Firm X MC P P AC S1 P1 D=AR=MR D1 Qd Q1 Qd

  10. New entrants into the market increase supply and the market price level falls Market Firm X MC P P AC S1 S2 D=AR=MR P2 D1 Qd Q2 Qd

  11. Now AC is greater than AR so there is a loss – and firms leave the market Market Firm X MC P P AC S1 S2 D=AR=MR P2 D1 Qd Q2 Qd

  12. Supply in the market falls back to S3 Market Firm X MC P P AC S3 S2 P3 D=AR=MR D1 Qd Q3 Qd

  13. Now AR = AC and there are only normal profits being made. Market Firm X MC P P AC S3 S2 P3 D=AR=MR D1 Qd Q3 Qd

  14. Market Firm X MC P P AC S3 S2 P3 D=AR=MR D1 Qd Q3 Qd In the long run only normal profits are made

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