Lecture 18

# Lecture 18 - Announcements HW due Wednesday 1 of 36 Perfect...

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Announcements HW due Wednesday 1 of 36

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Perfect Competition REMINDER: WE ARE NOW LOOKING ONLY AT THE SHORT RUN BEHAVIOR OF FIRMS! The firm’s only choice in perfect competition is to choose a level of output that will maximize profits. In the short run, to maximize profits, the firm would choose the level of output such that MR=MC. 2 of 33
3 of 31 OUTPUT DECISIONS: REVENUES, COSTS, AND PROFIT MAXIMIZATION COMPARING COSTS AND REVENUES TO MAXIMIZE PROFIT IN THE SHORT RUN The Profit-Maximizing Level of Output The Profit-Maximizing Level of Output for a Perfectly Competitive Firm

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4 of 31 OUTPUT DECISIONS: REVENUES, COSTS, AND PROFIT MAXIMIZATION As long as marginal revenue is greater than marginal cost, even though the difference between the two is getting smaller, added output means added profit. Whenever marginal revenue exceeds marginal cost, the revenue gained by increasing output by one unit per period exceeds the cost incurred by doing so. The profit-maximizing perfectly competitive firm will produce up to the point where the price of its output is just equal to short-run marginal cost—the level of output at which P* = MC . The profit-maximizing output level for all firms is the output level where MR = MC . (For perfectly competitive firms, P=MR.)
Maximizing Profits (PC firm) 5 of 33

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A graphical example 6 of 33 Maximizing Profits when Price = \$10 q P d=MR=AR=P AC MC 20 \$10 \$6.00 Max Profit \$5.00 15 Max Profit=TR-TC=(P-AC)*Q=(\$10-\$6)*20=\$80
Perfect Competition If you produce fewer than 20 units, you are giving away money because, if MR > MC, you could increase overall profits by increasing production. Producing more than 20 units reduces your profits. Above 20 units, MC > MR, so the extra economic cost of producing one more unit is more than you receive for producing it. This is why it is optimal to produce 20 units of output. 7 of 33

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8 of 31 OUTPUT DECISIONS: REVENUES, COSTS, AND PROFIT MAXIMIZATION A Numerical Example Profit Analysis for a Simple Firm (1) q (2) TFC (3) TVC (4) MC (5) P = MR (6) TR ( P x q ) (7) TC ( TFC + TVC ) (8) PROFIT ( TR - TC ) 0 \$ 10 \$ 0 \$ - \$ 15 \$ 0 \$ 10 \$ -10 1 10 10 10 15 15 20 -5 2 10 15 5 15 30 25 5 3 10 20 5 15 45 30 15 4 10 30 10 15 60 40 20 5 10 50 20 15 75 60 15 6 10 80 30 15 90 90 0 Here we don’t get P=MC so we stop production when P>MC and BEFORE MC rises above the price.
Choosing output so that P=MC is best for both society and the perfectly competitive firm. For a perfectly competitive firm, at P=MR=MC consumers place a dollar value on the last unit produced (P) that is exactly equal to the economic cost of producing it (MC). Therefore, the last unit is not more valuable in any industry other than the current one (as would be the case if MC> P). Nor, for that matter, do consumers value this unit more than it costs to produce it (as would be the case if P>MC). This is efficient. Society will produce the efficient mix of output

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## This note was uploaded on 06/21/2009 for the course ECON 2005 taught by Professor Zirkle during the Fall '07 term at Virginia Tech.

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Lecture 18 - Announcements HW due Wednesday 1 of 36 Perfect...

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