Professional Documents
Culture Documents
7
Profit Maximiza1on
Indre Deksnyte
Theme
Objec1ves
• Marginal
Revenue
• Profit
maximiza1on
and
loss
minimiza1on
• The
short-‐run
supply
curve
• The
long-‐run
supply
curve
• The
shut-‐down
and
break-‐even
points
PERFECTLY COMPETITIVE MARKETS
Price
Taking
Because
each
individual
firm
sells
a
sufficiently
small
propor5on
of
total
market
output,
its
decisions
have
no
impact
on
market
price.
● price taker Firm that has no influence over
market price and thus takes the price as given.
Product
Homogeneity
When the products of all of the firms in a market are perfectly
substitutable with one another—that is, when they are homogeneous—
no firm can raise the price of its product above the price of other firms
without losing most or all of its business.
What
are
the
main
goals
for
business?
MARGINAL REVENUE, MARGINAL COST,
AND PROFIT MAXIMIZATION
2 5 10 5 5 D,MR
3 5 15 5 4
4 5 20 5 3
5 5 25 5 2
6 5 30 5 1
0
0 1 2 3 4 5 6
Output
Profit Maximization and Loss
Minimization
Output Price TR MR TC ATC MC Total Profits
1 1 $200 $200 $200 $500 $500 $100 - $300
1 2 200 400 200 550 275 50 - 150
1 3 200 600 200 610 203 60 - 10
1 4 200 800 200 700 175 90 100
1 5 200 1000 200 830 166 130 170
1 6 200 1200 200 1000 167 170 200
1 7 200 1400 200 1205 172 205 195
Output MR MC 500
1 $200 $100
400
2 200 50
3 200 60 300
4 200 90
5 200 130 200
D,MR MC
The most profitable output is where the MC curve crosses the D, MR curve. This
occurs at an output of 6.7 units
Profit Maximization and Loss Minimization
Total Profit=(Price-ATC) X Output
TP=Total Profit; P=Price
500
TP=(P-ATC) X Output
TP=$200-$170) X 6.7
400
TP=$30 X 6.7
TP=$201
300
D,MR
Price is $200
MC
200
ATC
ATC is $170
100
The most profitable output is where the MC curve crosses the D, MR curve. This
occurs at an output of 6.7 units
Making Sure We Are Maximizing Profit
Output Profit
6.0. . . . . . . . . . . . . $200
If you calculated the total profit at
6.1
every level of output (6.1 through 6.9)
6.2 you would find that the output level of
6.3 6.7 units would provide you with the
6.4 greatest level of profit.
6.5 This is the output level where
6.6 MC=MR
6.7 . . . . . . . . . . . . . . 201 <------ Best that we can do!
6.8
6.9
7.0 . . . . . . . . . . . . . . 195
Profit Maximization and Loss Minimization
1,500
TP = -$431.60
1,100
MC
700
600 ATC
400
0
0 1 2 3 4 5 6 7
Output
Making Sure We Are Minimizing Losses
Output Profit
5.0 - $450.00
5.1
5.2 - 431.60 <----Best we can do!
5.3
If you calculated the total profit at every level
5.4 of output (5.1 through 5.9) you would find that
5.5 the output level of 5.2 units would provide you
with the smallest possible loss.
5.6
5.7 This is the output level where MC=MR
5.8
5.9
6.0 - 700.00
Producing
Exactly
at
the
Output
Level
Where
MC
=
MR
Enables
Us
to
Maximize
Total
Profits
(or
Minimize
Total
Losses)
• MR
is
the
addi1onal
revenue
from
selling
one
more
unit
of
output
• MC
is
the
addi1onal
cost
of
producing
one
more
unit
of
output
• We
keep
adding
to
output
as
long
as
MR
exceeds
MC
– If
we
stop
short
of
this
point,
we
would
not
maximize
our
profit
• We
stop
adding
to
output
when
MR
=
MC
– If
we
con1nued
to
add
output
MC
would
exceed
MR
and
this
would
diminish
our
profits
Shut-‐Down
Rule:
The
firm
should
shut
down
if
the
price
of
the
product
is
less
than
the
average
variable
cost
of
produc;on
at
the
profit-‐maximizing
output.
The
Short-‐Run
and
Long-‐Run
Supply
Curves
The Short-Run Supply Curve
A firm will always produce where MC equals MR
A firm will operate in the short-run if sales (TR) are greater than
variable cost (VC) [ Remember TR = Price X Output]
A firm will shut down if variable cost (VC) are greater than sales
(TR) [Remember, sales and TR are the same]
Alternatively
15
5 Shut-‐down point
0
0 1 2 3 4 5 6 7 8 9 10 11
Minimum point on the AVC Output
Four
Rules
• In
the
short
run
– If
the
price
is
below
the
shut-‐down
point,
the
firm
will
shut
down
– If
the
price
is
above
the
shut-‐down
point,
the
firm
will
operate
• In
the
long
run
– If
the
price
is
below
the
break-‐even
point,
the
firm
will
go
out
of
business
– If
the
price
is
above
the
break-‐even
point,
the
firm
will
stay
in
business
The Shut-Down and Break-Even Points
200
run? 160
MC
Answer: $125.50
140 Break-‐e ven
point ATC
D,MR
120
Output AVC ATC Total Profits AVC
3 106.67 140 - 30
80
4 102.50 127.50 + 10 0 1 2 3 4 5 6 7
Output
5 106 126 + 20
6 116.67 133.33 - 20
The Shut-Down and Break-Even Points
200
Calculate Total Profit
TP = (P – ATC) X Output 180
TP = 4 X 5.25 160
80
0 1 2 3 4 5 6 7
Output
Output is 5.25
The Shut-Down and Break-Even Points
200
D, MR
the long run if the price is MC
160
$170?
140 Break-‐e ven
D,MR
at an output of 6 120
AVC
100
In both the short run and the Shut-‐down
point
even point) 50
40
output? 20
10