Revenue and Profit Maximization

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Revenue and Profit Maximization
ECO 105 Lecture 2.6 26 September 2008
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Profit Maximization

• Profit Total Revenue - Total Cost
• P
• Recall TC
• Economic profit covers
• Note This means that a firm will stay in
  business if economic profit
• Of course, accounting profit will be

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Back to the handout . . .

• Suppose AHEC is selling 400 costumes at 1.10
  apiece.
• Then TR
• P TR TC
• Should AHEC increase or decrease production?
• Will more units add more

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What AHEC Discovers

• AHEC produces and sells 75 more costumes.
• P TR - TC
• Profit
• Should AHEC continue to expand?
• If so, how far?

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. . .

• At Q 535, P
• Profit has

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A Rule to Guide Us

• Note that, at Q 400, MC 0.80.
• But P
• Since AHEC is a price-taking firm,
• MR Marginal Revenue ?TR/?Q
• So

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• At Q 475, MR
• Thus, producing 75 additional costumes
• But at Q 535, MC
• Since MR lt MC, profit
• It seems weve discovered a rule.

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Profit Maximization

• To maximize profit, produce the level of output

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Two Types of Firms

• Price-taking firms
• Output decision has no effect on market price
• Examples Corn farmers, computer chip producers
• Price-searching firms
• Have some power to set prices
• Autos, shoes, electronics and many others

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Profit Maximization All Firms

• Expand output so long as MR gt MC
• In equilibrium, MR MC

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Price-Taking Firms

• Have no power to
• Therefore, P
• Rule Expand output until

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Example
Table 7.2
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Price-taking Firm
AR, MR
6
Q
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Price-searching firms

• Have the power to set price, although consumers
• Changing price affects revenue on all
• So MR ? P in fact,

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Example
Table 7.3
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Price-taking Firm
AR, MR
8
6
4
5
9
1
Q