Costs of Production and Profit Maximization Analysis

for the Perfect Competitive Market Structure

Total Average Average Average

Fixed Total Fixed Variable Total Marginal Market Price Marginal
Total Costs Variable Total Costs Costs Costs Costs Perfect Total Total Revenue
Output/hr (TFC) Costs (TVC) Costs (TC) (AFC) (AVC) (ATC) (MC) Competition Revenue Profit (MR)
0 $12.00 $0.00 $12.00 - - - - $6.00 $0.00 -$12.00 -
1 $12.00 $6.00 $18.00 $12.00 $6.00 $18.00 $6.00 $6.00 $6.00 -$12.00 $6.00
2 $12.00 $9.00 $21.00 $6.00 $4.50 $10.50 $3.00 $6.00 $12.00 -$9.00 $6.00 Marginal Costs = Marg
3 $12.00 $11.00 $23.00 $4.00 $3.67 $7.67 $2.00 $6.00 $18.00 -$5.00 $6.00
4 $12.00 $12.00 $24.00 $3.00 $3.00 $6.00 $1.00 $6.00 $24.00 $0.00 $6.00
5 $12.00 $14.00 $26.00 $2.40 $2.80 $5.20 $2.00 $6.00 $30.00 $4.00 $6.00
Maximum Profit at
6 $12.00 $17.00 $29.00 $2.00 $2.83 $4.83 $3.00 $6.00 $36.00 $7.00 $6.00
7 $12.00 $21.00 $33.00 $1.71 $3.00 $4.71 $4.00 $6.00 $42.00 $9.00 $6.00
8 $12.00 $26.00 $38.00 $1.50 $3.25 $4.75 $5.00 $6.00 $48.00 $10.00 $6.00
9 $12.00 $32.00 $44.00 $1.33 $3.56 $4.89 $6.00 $6.00 $54.00 $10.00 $6.00
10 $12.00 $39.00 $51.00 $1.20 $3.90 $5.10 $7.00 $6.00 $60.00 $9.00 $6.00
11 $12.00 $47.00 $59.00 $1.09 $4.27 $5.36 $8.00 $6.00 $66.00 $7.00 $6.00

Average Costs of Production Total Costs of Production

$20.00 $70.00 $7
$18.00 $60.00
$16.00 $6
$50.00
Production Costs

$14.00

Revenue and Costs

$5
Dollar Costs

$12.00 $40.00
$10.00 $4
$8.00 $30.00
$3
$6.00 $20.00
$4.00 $2
$2.00 $10.00
$0.00 $0.00 $1
1 2 3 4 5 6 7 8 9 10 11 1 2 3 4 5 6 7 8 9 10 11 12 $
Output Output

Average Fi xed Costs (AFC) - Average Vari a bl e Costs (AVC) - Tota l Fi xed Costs (TFC) Total Vari a bl e Costs (TVC)
Average Tota l Costs (ATC) - Ma rgi nal Costs (MC) - Tota l Costs (TC)
 1 2 3 4 5 6 7 8 9 10 11 1 2 3 4 5 6 7 8 9 10 11 12
$
Output Output

Average Fi xed Costs (AFC) - Average Vari a bl e Costs (AVC) - Tota l Fi xed Costs (TFC) Total Vari a bl e Costs (TVC)
Average Tota l Costs (ATC) - Ma rgi nal Costs (MC) - Tota l Costs (TC)

$20.
$18.

Price and Cost per Unit

$16.
$14.
$12.
$10.
1. Explain in your own words why MC=MR is the optimum level of output. $8.
The point at which marginal costs equal marginal revenue is the optimum level of output since this is where costs don't $6.
exceed revenues, and revenues don't exceed costs. If a firm produced where MC > MR then the firm would lose profits by $4.
producing additional units and should lower its output. If a firm was to produce where MC < MR then the firm isn't producing $2.
enough and should continue to produce more to maximize profit. Therefore, MC = MR is where you would receive the most profit. $0.

2. Assume prices dropped to $5.35. What then would be the profit maximizing or loss minimizing level of production ?
At a price of $6.00, the profit maximizing level of production is 9 units per hour. Dropping the prices down to $5.35 would
result in a profit maximizing level of production at 8 units per hour.

3. Explain how a perfectly competitive firm determines its optimum level of output.
A perfectly competitive firm determines its optimum level of output by continuing production until the cost of increasing
output by one more unit is equal to the revenues obtained from the extra unit (where Market Price = MR = MC). A firm should
compare the results of Market Price, MC, and MR to determine the point at which they are equal to get the best ouput.
 Costs = Marginal Revenue

mum Profit at Profit Maximizing Output

Profi t Maximization
$70.00
$60.00
Revenue and Costs

$50.00
$40.00
$30.00
$20.00
$10.00
$0.00
1 2 3 4 5 6 7 8 9 10 11 12
Output

Total Costs (TC) Total Revenue

 $0.00
1 2 3 4 5 6 7 8 9 10 11 12
Output

Total Costs (TC) Total Revenue

Measuring Total Profi ts

$20.00
$18.00
Price and Cost per Unit

$16.00
$14.00
$12.00
$10.00
$8.00
$6.00
$4.00
$2.00
$0.00
1 2 3 4 5 6 7 8 9 10 11
Output

Avera ge Total Costs (ATC) - Margi na l Costs (MC) -

Margi nal Revenue (MR) -
 Monopoly Profit Maximizing Analysis

Total Price Per Average Marginal

Output Unit Total Total Costs Total Price Total Costs Marginal Revenue
Units (Demand) Revenue (TR) (TC) (TP) (ATC) Costs (MC) (MR)
0 $7.10 $0.00 $9.00 -$9.00 - - -
1 $6.90 $6.90 $13.00 -$6.10 $13.00 $4.00 $6.90
2 $6.70 $13.40 $16.60 -$3.20 $8.30 $3.60 $6.50
3 $6.50 $19.50 $19.85 -$0.35 $6.62 $3.25 $6.10
4 $6.30 $25.20 $22.90 $2.30 $5.73 $3.05 $5.70
5 $6.10 $30.50 $25.80 $4.70 $5.16 $2.90 $5.30
6 $5.90 $35.40 $28.60 $6.80 $4.77 $2.80 $4.90
7 $5.70 $39.90 $31.35 $8.55 $4.48 $2.75 $4.50
8 $5.50 $44.00 $34.20 $9.80 $4.28 $2.85 $4.10
9 $5.30 $47.70 $37.40 $10.30 $4.16 $3.20 $3.70
10 $5.10 $51.00 $41.80 $9.20 $4.18 $4.40 $3.30
11 $4.90 $53.90 $47.80 $6.10 $4.35 $6.00 $2.90
12 $4.70 $56.40 $56.80 -$0.40 $4.73 $9.00 $2.50

Monopoly Profi t Determinati on Demand Price

$14.00

$12.00 MC = MR
Price, Marginal revenue, and Costs

$10.00 MC

$8.00 Pri ce Per Uni t (Dema nd) $7.10 Average Total Costs
Avera ge Tota l Costs (ATC) -
Ma rgi na l Costs (MC) -
$6.00
Ma rgi na l Revenue (MR) -

$4.00 Monopoly Profit

$2.00 MR

$0.00
1 2 3 4 5 6 7 8 9 10 11 12
 Ma rgi na l Costs (MC) -

Price, Marginal re
$6.00
Ma rgi na l Revenue (MR) -

$4.00

$2.00 MR

$0.00
1 2 3 4 5 6 7 8 9 10 11 12
Output

Revenue - Cost Comparison

$60.00 TR
$50.00
Total Costs/Total Revenue

TC
$40.00

$30.00

$20.00

$10.00

$0.00
1 2 3 4 5 6 7 8 9 10 11 12 13
Output

Tota l Revenue (TR) Tota l Costs (TC)

1. Explain in your own words why MC=MR is a profit maximizing production level for the
Monopoly
A monopolist can maximize its profits by producing at a level where MR = MC since this is
where marginal costs don't exceed marginal revenues, and revenues don't exceed costs. If
marginal revenues exceed marginal costs, the firm is producing too little and can increase profit
by increasing output. Likewise, if marginal costs exceed marignal revenues, the firm is producing
too much and can increase profits by decreasing output. This is very similar to perfect
competition, however, a monopolist's price levels are different than a compeititve's price levels,
which allows the monopoly to make excess profits.
2. Explain how the monoploist determines where to price his product
A monopolist determines where to price its product by setting MR = MC and identifying the
price corresponding to the quantity on the demand curve. This shows the maximum price that
can be charged to get maximum profit.

3. A monopoly is considered an inefficient use of resources for what two reasons? (explain)
A monopoly is an inefficient use of resources because it charges a price greater than the
marginal cost of production. That is because a monopolist has market control and faces a
downward-sloping demand curve. Another reason for inefficiency is that a monopolist does not
2. Explain how the monoploist determines where to price his product
A monopolist determines where to price its product by setting MR = MC and identifying the
price corresponding to the quantity on the demand curve. This shows the maximum price that
can be charged to get maximum profit.

3. A monopoly is considered an inefficient use of resources for what two reasons? (explain)
A monopoly is an inefficient use of resources because it charges a price greater than the
marginal cost of production. That is because a monopolist has market control and faces a
downward-sloping demand curve. Another reason for inefficiency is that a monopolist does not
efficiently administer resources. Resources are misallocated in such a way that too few
resources are being used in the monopolist's industry, and too many are being used elsewhere.