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Unformatted text preview: Profit Maximization The simple definition of profit is revenue minus cost ( = R C). Profit is the primary economic objective of a business. As a working hypothesis, the firm maximizes profit that basically defines rational firm regardless of whether it operates in a competitive or monopolistic environment. Since our primary interest is in production, the models used to describe market structure are output-oriented . The general condition for profit maximization is to choose outputs so that marginal revenue (MR or mr) is equal to marginal cost (MC or mc). This is just a simple corollary of the general rule of equating marginal benefits to marginal cost. The key difference between competitive and monopolistic is that the competitive firm cannot influence price by manipulating output. The simple way of saying this is that the competitive firm acts as a price taker . In sharp contrast, monopolistic firms set prices by manipulating the demand curve. Since price is functionally related to quantity, its choice of output indirectly determines the price of the output. Except for this key difference, there is no reason to distinguish between competition and monopoly: both types of firm maximize profit by buying inputs (labor and capital) in factor markets to produce outputs for sale in product markets. Individual Firm MARKET Individual Firm MARKET S D $/q P* $/Q q Q* Q Firm acts as a price-taker Pure Competition: Atomistic Firms Pure Competition: Atomistic Firms MR = p MR = p . . . . . . Figure 1a Figure 1b This distinction bears repeating: the only difference (at least, in the model) between competitive firms and monopoly firms relates to control over the price (p) of their outputs. Whereas competitive firms act as price takers and treat p as a constant, a monopolist controls price and knows that raising or lowering price directly effects how much output (q) consumers are actually willing to buy (higher p, lower q, and vice-versa). effects how much output (q) consumers are actually willing to buy (higher p, lower q, and vice-versa)....
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This note was uploaded on 05/09/2008 for the course ECN 212 taught by Professor Nancy during the Fall '07 term at ASU.
- Fall '07