Firms in a Competitive Market9

Profit Maximizing Rule

• Quantity (Q)– How many driveways did Mr. Plow clear?

• Price (P)– Price charged per driveway

• Total Revenue (TR)– TR = P Q

• Total Costs (TC)– Sum of all production costs at a certain level of output

• Profit (π)– π = TR – TC

Profit Maximizing Rule

• Marginal Revenue (MR)– MR = ΔTR ÷ ΔQ– Δ = change in– For a competitive firm, MR = P

• Marginal Cost (MC)– MC = ΔTC ÷ ΔQ– Additional costs of producing additional

units

Profit Maximizing Rule

• Change in Profit– ΔProfit = MR – MC

• Profit maximizing rule:– To maximize profits, the firm should use a

marginal analysis

– Profit is maximized by choosing the level of output such that

MR = MC

Profit Maximizing Rule

• Profit is maximized by choosing the level of output such that

MR = MC

• If MR > MC– The firm can increase profits by producing more Q

• If MR < MC– The firm has produced “too much” Q, and profits are

not maximized

Calculating Profits

Quantity TRP Q TC Profit

TR – TCMR

Δ TR ÷ Δ QMC

Δ TC ÷ Δ QChange in Profit

MR – MCΔ TR ÷ Δ Q

0 $0 $250 -$250

10 100 340 -240 $100 $90 10

20 200 410 -210 100 70 30

30 300 460 -160 100 50 50

40 400 490 -90 100 30 70

50 500 510 -10 100 20 80

60 600 540 60 100 30 70

70 700 600 100 100 60 40

80 800 700 100 100 100 0

90 900 950 -50 100 250 -150

100 1000 1250 -250 100 300 -200

Profit Maximization

Calculating Profit

• To find profit, we need to know revenues and costs– For a perfectly competitive firm, revenues can be

found by looking at the price (determined by the market) and the quantity sold

– Costs are determined by the quantity sold

• For the firm,

• Intuition: Profit = (units sold) ×(average profit per unit)

ATCPq

When to Operate or Shut Down

Profit and Loss in the Short Run

Condition Outcome

P > ATC The firm makes a profit

ATC > P > AVC The firm will operate to minimize loss

AVC > P The firm will temporarily shut down

Short Run Supply Curve

Long Run Supply CurveKapital – Not Changed

Long Run Shut Down Criteria

Condition Outcome

P > ATC The firm makes a profit

P < ATC The firm should shut down