Profit Maximization in the Short Run

Profit Maximization in the
Short Run
Mr. Henry
AP Economics
AP Review Questions from Yesterday
• A requirement of perfect competition is that
i. Many firms sell an identical product to many buyers
ii. There are no restrictions on entry into (or exit from)
the market, and established firms have no advantage
over new firms
iii. Buyers are well informed about prices
A. i only
B. i and ii
C. iii only
D. i and iii
E. i, ii, and iii
E. i, ii, and iii
• For a perfectly competitive corn grower in
Nebraska, the marginal revenue curve is
A. Downward sloping
B. The same as the demand curve
C. Upward sloping
D. U-shaped
E. Vertical at the profit maximizing quantity of
B. The same as the demand curve
Three Questions for TR-TC Approach
• Should we produce this product?
• If so, in what amount?
• What economic profit (or loss) will we realize?
What is the Total-Revenue – Total-Cost
• Perspective relies on the fact that profit equals
revenue minus cost and focuses on
maximizing this difference
• Economic profit is an incentive for
new firms to enter a market, but
as they do so, the price falls and
the economic profit of each
existing firm decreases. Economic
loss is an incentive for firms to exit
a market, and as they do so the
price rises and the economic loss
of each remaining firm decreases.
• Total revenue and total cost are
equal where the two curves in
9.2a intersect. This is called the
break-even point: an output at
which a firm makes a normal profit
but not an economic profit.
What is the Marginal-Revenue –
Marginal-Cost Approach?
• Perspective based on the fact that total profit
reaches its maximum point where marginal
revenue equals marginal cost.
• This is known as the MR=MC rule.
• A useful example for demonstrating that profit
maximization occurs where MR = MC, not where
MR is much greater than MC, is to ask a student if
she would trade $50 for $100 (of course), then $60
for $100 (of course), then $70 for $100, and so on
up to $99.99 for $100. The student should want to
trade as long as her additional “revenue” exceeds
her marginal cost. In other words, if someone can
make as much as $.01 more profit, the rational
person will trade. It is not the profit per unit but
the total profit that the seller is maximizing! This
simple notion bears repeating several times in
different ways, because some students will continue
to be puzzled by this despite its simplicity.
Loss Minimizing Case
Shut-down case
• If price P falls below the minimum AVC (here $74 at
Q=5), the competitive firm will minimize its losses in
the short run by shutting down. There is no level of
output at which the firm can produce and incur a loss
smaller than its total fixed cost.
Marginal Cost
and Short-Run