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.

back to the  top of this page
back to the  Microeconomics Home Page
back to  Professor Fisher's Home Page

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