Chapter 4: Profit maximization

If Py < ATC, then

profits are negative.

When the output price is below the ATC,

profits are negative.

If Py > ATC, then

profits are positive.

When the output price is greater than ATC,

profits are positive.

Vertical distance between TR and TC represents

profits; firm's objective is to maximize this distance.

At any level above shut down point, Py > AVC, the firm will

remain in business because the firm can meet all of its variable costs and at least part of its fixed costs.

The optimal, profit-maximizing (cost-maximizing) solution to negative economic profits is to

remain in business to minimize losses.

At output prices above the shutdown point, the firm will

remain in production.

Total Cost curve has typical shape because

shows costs increasing at a decreasing rate, then increasing at an increasing rate.

If the output price falls below the AVC curve, or Py < AVC, then the firm will

shut down because it is losing money on each unit of output produced.

At any level below the shutdown point, Py < AVC, the firm will

shut down because the firm cannot meet its variable costs of production

At output prices below the shutdown point, the firm will

shut down.

Marginal Revenue is also known as

the slope, or rate of change, in total revenue; = [change in total revenue] divided by [change in output]

Total Costs

the sum of all payments that a firm must make to purchase the factors of production; the sum of total fixed costs and total variable costs; TC = TFC + TVC

The break-even point occurs where

Py = MC at the minimum ATC point.

Economic profits are zero at the

break-even point.

The point of tangency is the output level consistent with maximum profit, which occurs at level Y*

this is the level at which the slope of TR is equal to the slope of TC, or MR = MC

In the long run, all fixed cots become

variable; the ATC curve is the same as the AVC curve; therefore, ATC = AVC, and AFC = 0.

1) In a perfectly competitive industry, resources flow

without cost to the desired jobs and locations

Explicit definition of profit is

π = TR - TC

When the price of corn increases, feedlots will

purchase less corn.

Shutdown point

the level of output at which marginal revenue (MR) is equal to average variable costs (AV)

Py, the price of the product

the market price received by produers when they sell their output (Y); USD/Y

1) Large number of buyers and sellers

There are so many firms selling a product, and so many consumers who purchase it, that each individual firm is so small relative to the market that it cannot affect the price

Marginal Revenue is the

addition to total revenue from selling one more unit of output; = [the difference in Total Revenue] divided by [the difference in output]

1) All competitive firms have access to

as few or as many factors (labor, land, capital, and management) as needed; no additional hidden costs

Continue any activity as long as

benefits outweigh the costs.

Total costs are the costs of production, including

both fixed and variable costs; all units in dollars

4) In a perfectly competitive industry, all buyers and sellers known all prices, quantities, qualities, and technologies that they use

called perfect information; no informational advantages in an industry characterized by perfect competitions

Marginal analysis

comparing the benefits and costs of a decision incrementally, one unit at a time; Also known as the economic approach to decision making

If the output price lies between average total costs and average variable costs, then the firm is

covering all of its variable costs, and part of the fixed costs.

1) In a perfectly competitive economy, firms hire as many inputs as required without affecting the price, since there are numerous buyers and sellers of inputs; in other words,

each individual firm is so small relative to the market that it cannot influence factor prices.

TR is constant; so, MR is constant for

every level of output

In a perfectly competitive industry, the output price is

fixed and given to a firm.

Under perfect competition, input and output prices are

fixed and given.

In the short run, a firm will have both

fixed and variable costs; so, fixed costs will still be present no matter the level of output.

Perfect Competition

fixed, constant prices

Lack of financial ability is not considered a rigid barrier to entry; so, agriculture is considered to have

freedom of entry and exit

All of the following have freedom of entry and exit

gas station, copy store, clothing store, NOT cable TV

A product that is the same no matter which producer produces it is the

homogeneous product; the producer of a good cannot be identified by the consumer

Price makers are firms in market structures other than competition that may be able to

influence the market price of a good.

1) In a perfectly competitive market, no individual firm can

influence the price charged for the industry's product; product price is constant; Refers to a price at a given place and at a given point in time

When the output price is exactly equal to the per-unit costs, the firm is

just "breaking even" where economic profits = 0 but no economic losses appear.

Barriers to entry refer to what kind of restrictions?

legal or government restrictions

If a tax is placed on gasoline, then a wheat producer will produce

less wheat.

Graphically, the profit maximizing level of output can be found by

locating the maximum vertical distance between the TR and TC curves.

3) Freedom of entry and exit

means that there are no "barriers to entry;" any firm can enter or leave the industry without encountering government obstacles or financial limitations

When the price of cars increases, Ford Motor Company will purchase

more glass, steel, and rubber.

1) Since numerous firms produce the same product, if one firm raises the price of the product above the price charged by the other firms, then

no buyers would pay the higher price and all of the customers would go to other firms.

The break even point

occurs when there are no economic profits or losses; Py = MC at the minimum point on the ATC

Average Revenue (AR) is the

per-unit revenue that the firm earns from the production and sale of a good.

A competitive firm is called a ------- since at any given moment it must take prices as fixed and given.

price taker; firm cannot change the price; no influence on prices

The major point to remember about perfect competition is that, in the short run,

prices of all inputs and outputs bought and sold by all producers and their customers are constant.

The firm minimizes losses by

producing where MR = MC, where total costs exceed total revenue.

At the break even point, the firm's revenue is exactly equal to the firm's costs or

profit = 0; price below ATC curve, economic costs become negative.

The shutdown point occurs where

Py equals minimum AVC.

The firm under study is in an

Industry characterized by Perfect Competition

Firm will continue to increase its level of output as long as the additional revenue from the production and sale of one more unit of the good is

*greater* than the additional costs of production incurred when producing an additional unit of output.

The profit maximizing level of output can be found by locating the point where

1) MR = MC and 2) MC cuts MR from below.

Perfect competition is defined by

1) a large number of buyers and sellers, 2) a homogeneous product, 3) freedom of entry and exit, and 4) perfect information.

To find the profit-maximizing level of output, the firm sets MR

= MC, or Py = MC

Which physical product curves can be graphed on the same graph?

APP and MPP

Average Revenue is also constant at the output price; since MR and AR are constant

MR = AR

As long as the firm is covering its variable costs, the firm will set

MR = MC and stay in production.

The profit-maximizing level of output can be found where

MR = MC, and MC cuts from below

The profit-maximizing level of output can be found where

MR = MC.

Two parts of the profit-maximizing condition

MR = MC; MC must cut MR from below.

The break-even point occurs where

P = MR = MC = ATC.

The shut-down point occurs where

P = minimum AVC

Profits = TR minus TC

Profits = [Py] times TC[Y]; TC is a function of Y; Both show that TR and TC are functions of quantity produced

π [profits] =

TR minus TC

The optimal, profit-maximizing point is

Y*, at which point TR > TC

TR =

[TPP] times [Py]

Total revenue is the amount of money earned from the production of a sale of a good; TR =

[TPP] times [Py] where Y is output; Py is price of output in USD per unit

Any change in TR comes from

a change in output, Y.

When MR = MC, any movement to the right or level of Y* will result in

a decrease in vertical distance between TR and TC, or a *reduction in profits*

Price maker

a firm characterized by market power, or the ability to influence the price of output; firm facing a downward-sloping demand curve

Price taker

a firm so small relative to the industry that the price of its output is fixed and given, no matter how large or how small the quantity of output it sells

A large number of buyers and sellers results in

a fixed and constant price.

Industry

a group of firms that produce and sell the same product

An industry is

a group of firms that produce and sell the same product.

4) Perfect information

a situation where all buyers and sellers in a market have complete access to technological information and all input and output prices

Marginal Cost is the

addition to total cost of producing one more unit of output; = [the difference in Total Cost] divided by [the difference in total output]

2) Homogeneous product assumption

states that one firm's product is identical to the product sold by all other firms in the industry

The key idea of the homogeneous product assumption is

that a consumer is indifferent regarding which firm produced the good.

Total Revenue

the amount of money received when the product sells the product.

Average Revenue

the average dollar amount received per unit of output sold; = [total revenue] divided by [Y]

Marginal analysis compares

the benefits and costs of every activity, one unit at a time.

You must continue any activity as long as

the benefits exceed the costs.

The point on a graph that shows that total revenue (TR) is equal to total cost (TC)

the break-even-point

When the output price is equal to the average total costs, then

the firm is breaking even and earning zero economic profits.

Even when a firm's profits are negative, the firm will remain in production when the price falls below the ATC curve because

the firm might be better off remaining in business in order to pay at least part of its fixed costs, which are going to be there no matter the level of output.

Remaining in business is a better choice than closing down and owing all fixed costs. Therefore,

the firm remains in business with negative profits to minimize losses.

Perfect Competition means that

the industry has four characteristics; 1) a large number of buyers and sellers, 2) a homogenous product, 3) freedom of entry and exit, and 4) perfect information

Marginal analysis suggests that an individual should continue any activity as long as

the marginal (incremental) benefits are greater than the marginal (incremental) costs.

Total Revenue curve will be a straight line because

the output, Py, is fixed and constant.