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.
