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TR = P x Q
TR
=P
AR =
Q
TR
MR =
Q
ACTIVE LEARNING
Exercise
1:
TR
$10
n.a.
$10
$10
$10
$10
$10
AR
MR
$40
$10
5
$10
$50
4
Profit Maximization
What Q maximizes the firms profit?
To find the answer,
Think at the margin.
If increase Q by one unit,
revenue rises by MR,
cost rises by MC.
Profit Maximization
(continued from earlier exercise)
At any Q with
MR > MC,
increasing Q
raises profit.
At any Q with
MR < MC,
reducing Q
raises profit.
TR
TC
$0
$5
$5
10
20
15
30
23
40
33
50
45
Profit MR MC
Profit =
MR MC
$10 $4
$6
10
10
10
10
10
12
5
7
Costs
MC
At Q1, MC = MR.
Changing Q
would lower profit.
MR
P1
Q a Q1 Q b
Q
8
Costs
MC
P2
MR2
P1
MR
Hence,
the MC curve is the
firms supply curve.
Q1
Q2
Q
9
Exit:
A long-run decision to leave the market.
10
revenue falls by TR
costs fall by VC
So, the firm should shut down if TR < VC.
Divide both sides by Q: TR/Q < VC/Q
So we can write the firms decision as:
Shut down if P < AVC
11
MC
ATC
AVC
Q
12
revenue falls by TR
costs fall by TC
So, the firm should exit if TR < TC.
Divide both sides by Q to rewrite the firms
decision as:
Exit if P < ATC
13
14
Costs
MC
LRATC
Q
15
2A:
Identifying a firms profit
ACTIVE LEARNING
A competitive firm
Determine
this firms
total profit.
Identify the
area on the
graph that
represents
the firms
profit.
Costs, P
MC
MR
ATC
P = $10
$6
50
16
2B:
Identifying a firms loss
ACTIVE LEARNING
A competitive firm
Determine
this firms
total loss.
Identify the
area on the
graph that
represents
the firms
loss.
Costs, P
MC
ATC
$5
MR
P = $3
30
17
18
19
One firm
MC
P3
P3
P2
P2
AVC
P1
Market
S
P1
10 20 30
Q
(firm)
Q
(market)
10,000
20,000 30,000
20
21
22
One firm
MC
Market
LRATC
P=
min.
ATC
long-run
supply
Q
(firm)
Q
(market)
24
25
S2
ATC
P2
P2
P1
P1
Q
(firm)
B
A
long-run
supply
D1
Q1 Q2
Q3
D2
Q
(market)
26
27
At any P,
29
Profit-maximization:
Perfect competition:
So, in the competitive eqm:
MC = MR
P = MR
P = MC
CHAPTER SUMMARY
For a firm in a perfectly competitive market,
price = marginal revenue = average revenue.