Econ 4010 Lecture 15

# Econ 4010 Lecture 15 - 8 Profit Maximization...

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<Lecture 15> 8. Profit Maximization and Competitive Supply A fundamental problem faced by every firm: How much should be produced? Profit Maximization Profit: Difference between total revenue and total cost π(q) = R(q) – C(q) Short Run Profit Maximization (p.265) Profit is maximized at the point at which an additional increment to output leaves profit unchanged, i.e., dπ / dq = 0: dπ / dq = dR / dq – dC / dq = 0 => MR(q) = MC(q) Thus, profit is maximized when marginal revenue is equal to marginal cost. TR = p*q => Competitive Market => MR = p => MR = p = MC(q) Short Run Profit Maximization (p.268) 1

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Shut-Down Rule: The firm should shut down if the price of the product is less than the average economic cost of production at the profit –maximizing output. Suppose that the firm has incurred a large sunk cost, which it treats as an ongoing fixed cost, and suppose that there are no other fixed costs. In this case, the firm's average variable cost is now the appropriate measure of the firm's average economic cost of production. (ATC – AVC)q cannot be avoided even if the firm shuts down. Average economic cost is equal to average total cost when there are no sunk costs but equal to average variable cost when costs treated as fixed are actually sunk costs. Short Run Supply Curve (p.273) A supply curve for a firm tells us how much output it will produce at every possible price. The firm's supply curve is the portion of the marginal cost curve for which marginal cost is greater than average economic cost. In the case in which all fixed costs are sunk costs, the short-run supply curve is given by the crosshatched portion of the MC curve. Q1. The data in the following table give information about the price for which a firm can sell a unit of output and the total cost of production. In the table, P is assumed to be \$60. Q 0 1 2 3 4 5 6 7 8 9 10 11 TR TC 100 150 178 198 212 230 250 272 310 355 410 475 π MR MC a. Fill in the blanks in the table. 2
b. Show what happens to the firm's output choice and profit if the price of the product falls from \$60 to \$50. Q 1 2 -- 5 -- 8 9 10 11 TR 50 100 -- 250 -- 400 450 500 550 TC 150 178 -- 230 -- 310 355 410 475 π -100 -78 -- 20 -- 90 95 90 75 At a price of \$60, the firm should produce 10 units of output to maximize profit because this is the point closes to where price equals marginal cost without having marginal cost exceed price. At a price of \$50, the firm should produce 9 units to maximize profit. When price falls from \$60 to \$50, profit falls from \$190 to \$95.

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