ECON10A_17 (2)

# ECON10A_17 (2) - Supply 1 Market Homogeneous commodity...

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1/4/2008 1 Profit Maximization and  Supply

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1/4/2008 2 Assumptions - Perfectly Competitive  Market: Homogeneous commodity Large number of firms: (Each firm assumes its actions have no effect on market price) Free entry in long run Perfect information Prices known by all participants
1/4/2008 3 LAW OF ONE PRICE In equilibrium, all transactions occur at one price

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1/4/2008 4 Profit Maximization - Algebraically Maximize Total Revenue minus Total Cost max PQ-LTC(Q,w,r) Q FOC: Q* solves: (P=LMC(Q*,w,r)) Solution function is Q*(P,w,r) Q r)/ w, LTC(Q, P =
1/4/2008 5 Intuition:  What if P>LMC?      What if P < LMC? Suppose P=20 , LMC(Q, w,r)=12 Produce 1 more (Get 20, costs 1 2 , so this gives firm \$8 more profit.) If P still more than LMC, produce 1 more. Keep producing more output until P=LMC (LMC is eventually rising with Q so eventually LMC does reach P). Suppose P=20 , LMC(Q, w,r)=30 Produce 1 less (Lose 20, save 30 in costs, so this gives \$10 more profit.) If P still less than LMC, produce 1 less. Keep reducing output until P=LMC (LMC is eventually rising in Q so eventually LMC does fall to P, as Q falls). Conclusion: Neither P>LMC(Q,w,r) nor P<LMC(Q,w,r) is optimum.

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1/4/2008 6 Profit Max - Graphically What is the slope of the Total Revenue curve shown here? A. P B. Q C. w D. r Q \$ LTC TR
1/4/2008 7 Profit Max - Graphically Where is maximum profit? A. B. C. D. Q \$ LTC TR A B C D

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1/4/2008 8 Profit Max - Graphically Slope of Total Revenue curve= P Slope of LTC = =LMC When LTC flatter (P>LMC): gap widening so… Distance (profit) not at maximum When LTC steeper (P<LMC): gap narrowing… Distance (profit) not at maximum Profit Max where P=LMC Q \$ Q LTC TR π widening narrowing Q LTC/
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ECON10A_17 (2) - Supply 1 Market Homogeneous commodity...

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