• Price determined by S & D
• Price taker
• Won’t charge higher or lower than market
price
• Horizontal (perfectly elastic) at market price.
Market demand
Individual firm
Firms aim to maximise profit
Two rules for profit-maximisation
• shut-down rule
• profit maximising rule
The shut-down rule: a firm should produce only
if total revenue is equal to, or greater than,
total variable cost (which includes normal
profit).
Profit is maximised where marginal revenue
(MR) is equal to marginal cost (MC).
In summary…
• When MR > MC, output should be expanded
• When MR = MC, profits are maximised
• When MR < MC, output should be reduced
POINT
a:
MR
(R10)
MC
(R4)
R6
POINT
POINTe:d:
c:
b:MR
MR(R10)
(R10)–––MC
MC(R12)
(R8)
(R10)
(R6)===R2
-R2
R4
R0
Profit Maximising Level
Perfect Competition
Normal profits: occur when total costs = total
revenue.
Minimum earnings required to prevent
entrepreneur leaving and applying factors of
production elsewhere.
As ARprofit
= AC,
the firm
earn
an
Normal
earned,
sincedoes
all itsnot
costs,
including
Profit
isEAt
maximised
where
MR
Q
This
2, break
AR
occurs
=
P
2 =at
AC
Q
(C
2 =
2) MC = P2
2 aka
even
point
self-employed
resources,
are
fully
economic profit. covered.
0CTR
2also
E2Q=2 (TC)
2by
E22EQTR
2 (TR)
P
2 Xfound
Q=2 =0P0P
2Q
2 - TC
Can
TC
Cbe
0C
Economic profits: profit that a business makes
that is more than the normal profit.
Economic profit occurs when total revenue >
total costs.
AKA excess profit, abnormal profit, supernormal
profit or pure profit.
Economic profit earned – above breakeven
Profit isAtmaximised
MR
= P3
AtQ3This
Q, AR
3, AR
(P
) >atAC
)CMC
occurs
=point.
Pwhere
3 3and
AC
Q(C
3 =1=
1
0P3E3Q3 (TR) > 0C1MQ3 (TC)
===CP
13 X
Q
0C
TR
Xfound
Q33 == Profit
0P
ETR
3=
QC331-P1TC
Can TC
also
be
by13MQ
Difference
Economic
E3M
Economic loss: occurs when a firm makes less
than normal profit.
• I.e. price (AR) < AC
Profit isAtEconomic
maximised
where
MR
= P3
3, 3AR
occurs
= (P
Ploss
33)
and
=AC
CAC
Q
3 3(C
– =P3=)3CMC
3
AtQThis
Q
, AR
<at
0P3E3Q3 (TR) < 0C1MQ3 (TC)
TR
===CP
33 X
Xfound
Q
Q33 == 0C
0P
E=TR
3Q
Can TC
also
be
by33MQ
TC3
Difference
Economic
Loss
P333C-3ME
If a firm is making an economic loss,
should they leave the market?
Depends on average revenue (P)
relative to average VARIABLE costs.
If P < AVC, best to leave the industry.
Allocative efficiency: a situation where it is impossible
to reallocate the resources to make at least one
person better off without making someone else worse
off.
Allocative inefficiency: it is possible to make at least
one person better off without making someone else
worse off.
In such a case the welfare of society can be improved
by reallocating the resources.
Society’s welfare maximised when…
P (OC of consuming extra unit)
=
MC (OC of producing extra unit)
Are perfectly competitive firms allocatively
efficient?
• P = MR
• Profit maximisation at MR = MC
• Therefore they produce at P = MR = MC
Productive efficiency: occurs when all the firms
in the industry produce where their long-run
average or unit costs are at a minimum.
When this occurs – no waste of scarce
resources.
Perfectly competitive firms in equilibrium in the
long run where average cost is at a minimum –
thus productively efficient.