PROFIT MAXIMISATION AND
COMPETITIVE SUPPLY
Profit maximization short term
Cost,
Income,
Profit
Slope of R(q) is MR & Slope of C(q) is
MC.
A
B
0
Profit max.
where the
difference
R(q) between R(q) –
C(q) is the
greatest.
Distance
between A and
B is the
greatest.
C(q)
q0
q*
Output
(q)
Competitive Firm
Price
Firm
Price
Industry
S
$4
d
$4
D
100
200
Q
100
Q
Short run – Positive Profit

Capital is fixed
Price
MC
50
A
40
AR=MR=P
ATC
AVC
30
q1 : MR > MC
q2: MC > MR
q*: MC = MR
20
10
0
1
2
3
4
5
MC(q) = MR = P = AR
6
7
q1
8
q*
9
q2
10
11
Output
Short run- Positive Profit
Price
50
40
MC
Total
Profit=
ABCD
A
D
AR=MR=P
ATC
30 C
AVC
B
20
10
0
1
2
3
4
5
6
7
q1
8
q*
9
q2
10
11
Output
Short run – Incurring losses
MC
Price
ATC
Loss
C
B
D
A
P = MR
AVC
F
E
q*
Output
Competitive firm – Short run supply
Price
MC
S
P2
ATC
P1
AVC
P = AVC
q1
q2 Output
Competitive firm – Short run supply
Price
MC2
Input cost increase,
MC shifts to MC2
MC1
$5
q2
q1
Output
Competitive firm – Short run supply
S
Market supply = sum of
the individual firms
supply.
Price
P3
P2
P1
2
4
5
7 8
10
15
21
Quantity
Producer Surplus in the short run
Price
MC
Producer surplus
AVC
B
A
P
q*
Output
Producer Surplus in the short run
Price
S
P*
Producer surplus
D
Q*
Output
Choosing output in the long run
Price
LMC
LAC
SMC
SAC
$40
D
A
P = MR
C
B
$30
q1
q2
q3
Output
Choosing output in the long run
Over the long run capacity can increase.
Output can increase to q3.
Long run profit, EFGD > short run profit ABCD.LMC
Prys
LAC
SMC
SAC
$40
D
A
P = MR
C
B
G
$30
F
q1
q2
q3
Uitset
Choosing output in the long run
Price
Prys
Firm
Industry
S1
LMC
$40
LAC
P1
S2
P2
$30
D
q2
Output
Q1
Q2
Uitset
Choosing output in the long run
Price
Firm
Prys
LMC
Industry
S2
LAC
$30
P2
S1
P1
$20
D
q2
Output
Q2
Q1
Uitset
Economic rent
Price
Profit = 0
LMC
LAC
$7
Quantity
1.0
Economic rent
Price
Economic rent
LMC
LAC
$10
$7.20
Sell at a higher price in
another town.
Q
1.3
Constant-cost industry
Price
MC
Industry
Price
Firm
S1
AC
P2
P2
P1
P1
S2
SL
D1
q1 q2
Output
Q1
Q2
D2
Output
Increasing-cost industry
Firm
Industry
SMC2
Price
Prys
SMC1
LAC1
P2
S1 S2
LAC2
P2
P3
P3
P1
P1
D1
q1
q2
Output
SL
Q1 Q2 Q3
D2
Output
Decreasing-cost industry
Price
Industry
Firm
Price
SMC1
S1
S2
SMCLAC
2
1
LAC2 P2
P2
P1
P1
P3
P3
SL
D1
q 1 q2
Output
Q1 Q2 Q3
D2
Output
Effects of tax: firm
Price
MC2 = MC1 + tax
Tax increase the MC and AVC
MC1
The firm will
decrease its output
until
MC + tax = P
t
P1
AVC2
AVC1
q2
q1
Output
Effects of tax: industry
Price
S2 = S1 + t
S1
t
P2
Tax reduce supply, increase
the price
P1
D
Q2
Q1
Output