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Micro Ch 21

Micro Ch 21. Presentation 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.

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Micro Ch 21

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  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 Price = $131 (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 (-) $100 100 100 100 100 100 100 100 100 100 100 0 1 2 3 4 5 6 7 8 9 10 $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 Do You See Profit Maximization? Now Let’s Graph The Results…

  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. $1800 1700 1600 1500 1400 1300 1200 1100 1000 900 800 700 600 500 400 300 200 100 W 21.1 Total Revenue and Total Cost G 21.1 0 0 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 10 10 11 11 12 12 13 13 14 14 Quantity Demanded (Sold) $500 400 300 200 100 Total Economic Profit Quantity Demanded (Sold) Profit Maximization in the Short Run Total Revenue-Total Cost Approach Break-Even Point (Normal Profit) Total Revenue, (TR) Maximum Economic Profit $299 Total Cost, (TC) P=$131 Break-Even Point (Normal Profit) Total Economic Profit $299

  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. $200 W 21.2 150 Cost and Revenue 100 50 0 1 2 3 4 5 6 7 8 9 10 Output Profit Maximization in the Short Run MR = MC P=$131 MC Economic Profit MR = P ATC AVC A=$97.78

  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. $200 150 Cost and Revenue 100 50 0 1 2 3 4 5 6 7 8 9 10 Output Profit Maximization in the Short Run Loss Minimizing Case Marginal Revenue-Marginal Cost Approach MR = MC Rule Lower the Price to $81 and Observe the Results! MC Loss ATC AVC MR = P P=$81 V = $75

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

  15. $200 150 Cost and Revenue 100 50 0 1 2 3 4 5 6 7 8 9 10 Output Profit Maximization in the Short Run Marginal Revenue-Marginal Cost Approach MR = MC Rule Short-Run Shut Down Case Lower the Price Further to $71 and Observe the Results! MC ATC V = $74 AVC MR = P P=$71 Short-Run Shut Down Point P < Minimum AVC $71 < $74

  16. Cost and Revenues (Dollars) Quantity Supplied Marginal Cost and Short-Run Supply Generalizing the MR=MC Relationship and its Use Examine the MC for the Competitive Firm MC Above AVC Becomes the Short-Run Supply Curve S Break-even (Normal Profit) Point MC e P5 MR5 d ATC P4 MR4 c AVC P3 MR3 b P2 MR2 a P1 MR1 Shut-Down Point (If P is Below) This Price is Below AVC And Will Not Be Produced Q2 Q3 Q4 Q5 0

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

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