Profit Total Revenue Total Cost

1
Profit Total Revenue - Total Cost Marginal
Revenue (MR) Change in total revenue from
selling one more unit of output ?TR/?Q Marginal
Cost (MC) Change in total cost from producing
one more unit of output ?TC/?Q Maximize profit
by producing where MR MC produce (and sell)
until extra cost just equals extra revenue ?
Produce until marginal profit 0 MR gt MC ?
output will be increased MR lt MC ? output will
be decreased MR MC ? output will not be changed
2
Firms in Markets Perfect Competition - many
firms Monopoly - one firm Monopolistic
competition and Oligopoly (In Between)
3
Perfect Competition Large number of buyers and
sellers ? market participants take
price Homogeneous product ? Role of
advertising? Perfect information ? One
price Free entry to and exit from the market ?
No advantage to incumbency So, what will
(economic) profits be?
4
Why do perfectly competitive firms take
price? Market Elasticity (E) ?Q/?P
(?Q/Q) / (?P/P) Note Q ?q Nq with N
identical firms Firms Elasticity (EF)? Note E
(?Q/Q) / (?P/P) (?q/Nq) / (?P/P) ? EF
(?q/q) / (?P/P) NE hence firms demand is
very elastic Note ?q/?P large ? ?P/?q small
5
Examples E N Ef ?P .1 100 10 .5
50 25 .7 1000 700 .6 10 6
1 .4 .01 1.7
?P from a 10 change in q What effect can one
firm have on price? None
6
The demand curve for a perfectly competitive firm
is horizontal at the market price (why?) Thus,
MR ?TR/?Q P So, firm maximizes profit by
producing where MR P MC When does firm
decide to shutdown in the short run?
7
Demand, Price, and Revenuein Perfect Competition
Cindys demand and marginal revenue
Sweater market
50
50
Price (dollars per sweater)
Price (dollars per sweater)
25
25
0 9 20 0 10 20
Quantity (thousands of sweaters per day)
Quantity (sweaters per day)
8
A Firms Short-Run Supply Curve
31
Marginal revenue marginal cost (dollars per
day)
25
17
7 9 10
0
Quantity (sweaters per day)
9
The Firms Short-Run Supply Curve

• Fixed costs must be paid in the short-run.
• Variable-costs can be avoided by laying off
  workers and shutting down.
• Firms shut down if price falls below the minimum
  of average variable cost.

10
A Firms Short-Run Supply Curve

31
Marginal revenue marginal cost (dollars per
day)
25
17
Q
7 9 10
0
Quantity (sweaters per day)
11
Short-Run Industry Supply Curve

• Short-run industry supply curve
• Shows the quantity supplied by the industry at
  each price when the plant size of each firm and
  the number of firms remain constant.
• It is constructed by summing the quantities
  supplied by the individual firms.

12
Short-Run Equilibrium
Increase in demand price rises and
firms increase production
S
Price (dollars per sweater)
25
20
17
Decrease in demand price falls and
firms decrease production
D1
6 7 8 9 10
0
Quantity (thousands of sweaters per day)
13
Profits and Losses in the Short-Run

• At short-run equilibrium firms may
• Earn a profit
• Break even
• Incur an economic loss.

14
Profits and Losses in the Short-Run

• If price equals average total cost a firm breaks
  even.
• If price exceeds average total cost, a firm
  makes and economic profit.
• If price is less than average total cost, a firm
  incurs an economic loss.

15
Three Possible Profit Outcomesin the Short-Run
Normal profit
30.00
MC
ATC
Price (dollars per chip)
25.00
20.00
15.00
0
8 10
Quantity (sweaters per day)
16
Three Possible Profit Outcomesin the Short-Run
Economic profit
30.00
MC
ATC
Price (dollars per chip)
25.00
20.33
15.00
0
9 10
Quantity (sweaters per day)
17
Three Possible Profit Outcomesin the Short-Run
Economic loss
30.00
MC
ATC
Price (dollars per chip)
25.00
20.14
17.00
7 10
0
Quantity (sweaters per day)
18
Long Run Equilibrium in Perfectly Competitive
Markets - Economic profits will attract entry of
new firms - Economic losses will cause some
existing firms to exit Two features of long run
equilibrium 1) Existing firms operate to
maximize profit ? P ( MR) MC 2) Economic
profits must be zero ? P LRAC (long run
average cost) How can both of these occur?
19
Long Run Costs and Price - All costs are
variable - MC intersects LRAC at minimum of LRAC
(why?) Thus, P MC minimum LRAC characterizes
long run equilibrium in a perfectly competitive
market Thus, price in perfectly competitive
market is completely determined by cost in the
long run
20
Long Run Equilibrium for a Firm in a
Perfectly Competitive Market
21
An Increase in Demand How Does Market Get to
New Equilibrium? (picture on next slide) ? 1)
P increases ? 2) Economic profit is positive
? 3) New firms enter market ? 4) Q increases
(SR supply shifts out) ? 5) P decreases
? New equilibrium P MC min. LRAC What if
Demand decreases?
22
Effect of an Increase in Demand
23
An Increase in Costs How Does Market Get to New
Equilibrium? (picture on next slide) ? 1)
LRAC shifts up ? 2) Economic profit is
negative (losses) ? 3) Some firms exit market
? 4) Q decreases (SR supply shifts in) ? 5)
P increases ? New equilibrium P MC min.
(new) LRAC What if Costs decreases?
24
Effect of an Increase in Costs
25
Market Supply in the Long Run 1) How does
quantity supplied vary in the LR? - Entry/Exit
2) What does P equal in the LR? - minimum
LRAC Thus, shape of LR Supply Curve is
determined by how minimum LRAC changes as firms
enter/exit the market
26
Long Run Supply Two cases 1) Constant Cost
Industry Minimum LRAC does not change as firms
enter/exit the market (why?) ? LR Supply curve
is horizontal 2) Increasing Cost Industry
Minimum LRAC increases as firms enter the market
(and decreases as firms exit) (why?) ? LR
Supply curve is upward-sloping (picture on
next slide)
27
Long Run Supply in an Increasing Cost Industry