The Competitive Firm
The Profit Motive
  • Profit  =  total revenue - total cost
  • The basic incentive for producing goods and services is the expectation of profit
  • Personal reasons, such as the need for control or identity, also motivate producers.
Economic Profits
  • Economic Profit:  the difference between total revenues and total economics costs.
  • Economic profits account for all resources
    • Economic profits represent something over and above "normal profits”.
    • A productive activity reaps an economic profit only if it earns more than its opportunity cost.
  • Entrepreneurship:  the inducement to take on the added responsibilities of owning and operating a business is the potential for profit.
  • Risk:  The potential for profit is not a guarantee of profit.
Market Structure
  • Market structure  - The number and relative size of firms in an industry.
  • Perfect competition  - A market in which no buyer or seller has market power.
    • a perfectly competitive firm is one whose output is so small relative to the market supply that it has no significant effect on the total quantity or price in the market.
    • a perfectly competitive firm confronts a horizontal demand curve for its own output.
  • Monopoly - A firm that produces the entire market supply of a particular good or service.
  • Market Power  - The ability to alter the market price of a good or service.
The Production Decision
  • We want to select the short-run rate of output (with existing plant and equipment) that will maximize profits.
  • Maximizing profits does not mean maximizing revenues!
  • To maximize profits a firm must consider how increased production will affect costs as well as revenues.
  • The primary objective of the producer is to find that one particular rate of output that maximizes profits.
Profit-Maximizing Rule
  • Profits are maximized when  marginal revenue (price) = marginal cost
  • Marginal Revenue (MR) is the change in total revenue that results from a one-unit increase in the quantity sold.
  •                       change in total revenue
    marginal revenue  =  -------------------------
                             change in output

  • short-run profit maximization rules for the competitive firm:
    • Price > MC  ==>  increase output
    • Price = MC  ==>  maintain output because profits are maximized
    • Price < MC  ==>  decrease output
  • The profit-maximizing producer never seeks to maximize per-unit profits.
  • The profit-maximizing producer has no desire to produce at that rate of output where ATC is at a minimum.



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this page is maintained by Reed Fisher
last updated January 15, 2011