MEDITERRANEAN SCHOOL OF BUSINESS COURSE: ECO 511 BUSINESS ECONOMICS 1 11/15/18 SOUTH MEDITERRANEAN UNIVERSITY PROFESSOR: Alec Hansen, Ph.D. DATE: October 2018
SESSION 2 REVIEW OF STATIC COMPETITION DYNAMIC COMPETITION MARKET CONCENTRATION GAME THEORY COURNOT EQUILIBRIUM 2
Firms’ Decisions 3 Profit maximizing behavior The total revenue and total cost approach The marginal revenue and marginal cost approach Short-run: shut down rule Long-run: exit rule
Total Revenue 4 The total inflow of receipts from selling a given amount of output Each time the firm chooses a level of output, it also determines its total revenue • Why? Total revenue—which is the number of units of output times the price per unit—follows automatically TR = P x Q
The Total Revenue And Total Cost Approach 5 At any given output level, we know • How much revenue the firm will earn • Its cost of production In the total revenue and total cost approach, the firm calculates Profit = TR – TC at each output level • Selects output level where profit is greatest
The Marginal Revenue and Marginal Cost Approach 6 Marginal Cost: change in total cost from producing one more unit of output Marginal revenue: change in total revenue from producing one more unit of output The GOLDEN RULE OF ECONOMICS TO MAXIMIZE PROFIT, SET QUANTITY WHERE MR=MC
The Marginal Revenue and Marginal Cost Approach 7 When a firm faces a downward sloping demand curve, each increase in output causes • Revenue gain ◦ From selling additional output at the new price • Revenue loss ◦ From having to lower the price on all previous units of output ◦ Marginal revenue is therefore less than the price of the last unit of output
Using MR and MC to Maximize Profits 8 Marginal revenue and marginal cost can be used to find the profit-maximizing output level • Logic behind MC and MR approach ◦ An increase in output will always raise profit as long as marginal revenue is greater than marginal cost (MR > MC) • Converse of this statement is also true ◦ An increase in output will lower profit whenever marginal revenue is less than marginal cost (MR < MC) • Guideline firm should use to find its profit-maximizing level of output Firm should increase output whenever MR > MC, and decrease output when MR < MC
Profit Maximization 9 Total Fixed Cost TC TR TR from producing 2nd unit TR from producing 1st unit Profit at 3 Units Profit at 5 Units $3,500 3,000 2,500 2,000 1,500 1,000 500 Output Dollars 1 2 0 3 4 5 6 7 8 9 10 Profit at 7 Units
Profit Maximization 10 profit rises profit falls MC MR 0 600 500 400 300 200 100 –100 –200 Output Dollars 1 2 3 4 5 6 7 8
Exercise Demand: Q = 100 – P Costs: MC = AC = 10 Hence P = 100 – Q Revenue: R = PQ = (100 -Q) Q MC = AC = 10 implies that costs are C = 10 Q Profit: Π = R-C = (100-Q)Q -10 Q = (100Q -Q 2 )-10Q Want to find Q* (and therefore P*) that maximizes Π 12
Solution Profit: Π = (100Q -Q 2 ) -10Q Take derivative: d Π/dQ = (100 -2Q) – 10 [ = MR – MC ] Profits are maximized where dΠ/dQ = 0 (100 -2Q) – 10 = 0 [MR – MC = 0] Q* = 45 Insert profit-maximizing value of Q into demand equation: P* = 100 - Q = 55 13
Profit Maximization by Monopoly MC curve crosses MR curve from below 14 E MR 10,000 MC D 30,000 40 $60
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