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Unformatted text preview: Profit Maximization under Perfect Competition How a single product firm chooses how much to supply when it competes for sales with many other suppliers The marginal cost curve: s s s Cost per unit Marginal cost will lie below AVC when AVC is declining and above it when AVC is rising MC = AVC when AVC is at its minimum MC is related to the o marginal product of Q* labor: MC =w/MP MC AVC Point of diminishing returns Q Short-run cost curves Cost ($ per unit) MC AC AVC Output Cost ($ per unit) AFC = AC - AVC AFC Output Perfect Competition s s s s s s Many Sellers Standardized Product Sellers have small shares of the market Firms do not consider the reactions of competitors when deciding how much to produce or what price to charge Free entry into and exit from the market Marginal Revenue = Price Under perfect competition firms are "Price Takers": They can sell all they choose to at the market price Market Price ($ per bushel) Competitive Firm Price ($ per bushel) Supply 2 Demand Firm's Demand Millions of bushels per year Thousands of bushels per year In Economics we assume that firms seek to maximize profit from the sale of their output Profit = Total Revenue - Total Cost s All economic costs (implicit and explicit) are included in total cost s Implicit costs are those of non-purchased inputs such as labor supplied by an owneroperator or the opportunity cost of owners capital (or equity) s "Normal Profit" is the cost of nonpurchased inputs s Cost and Price ($ per unit) Marginal cost Average cost 300 Profit=(P-AC)Q Demand = Price = MR 0 1 2 3 4 5 6 The marginal revenue (MR) is the extra benefit from selling one more unit of output. Under perfect competition MR = P. To maximize Profit the firm must compare MR and MC. 7 8 Output Cost and Price ($ per unit) Marginal cost Average cost 300 Profit=(P-AC)Q Demand = Price = MR Profit = TR - TC = PQ - AC(Q) = (P-AC) Q 0 1 2 3 4 5 6 7 8 Output (Units per day) A profit-maximizing firm adjusts output until marginal cost increases to marginal revenue. Under perfect competition this means P=MC in equilibrium. Cost and Price ($ per unit) Firms do not always earn profits: If market price falls below minimum possible average cost, maximum possible profit is negative. Selling the output for which P = MC minimizes losses Marginal cost Losses Average cost Average variable cost 200 Demand = Price = MR 0 1 2 3 4 5 6 7 8 Output Units per day in thousands The Shutdown Point: When price falls to minimum possible AVC, economic losses = fixed cost Cost and Price ($ per unit) Marginal cost Losses=FC Average cost Average variable cost 155 0 1 2 3 4 5 6 Demand = Price = MR 7 8 Output Units per day The competitive firm's supply curve Price and cost ($ per unit) MC AVC The portion of the marginal cost curve above the AVC curve is the short-run supply curve 0 Output ...
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This note was uploaded on 10/13/2008 for the course EC 205 taught by Professor Hymen during the Fall '08 term at N.C. State.

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