Maximizing Profits: Five-Step Process

Aug 7, 2024

Lecture Notes: Five-Step Process for Maximizing Profits

Introduction

  • Discussing the five-step process for maximizing profits.
  • Practice problems 31, 32, and 33 will be used to illustrate the process with specific numbers and tables.

Basic Concepts

  • Market Price: The table shows a market price of $20.
  • Marginal Revenue (MR): Under perfect competition, MR equals price.
  • Marginal Cost (MC): There is a marginal cost table to analyze.

Step 1: Finding MR = MC

  • Determine where marginal revenue equals marginal cost.
  • Notice that the MR line intersects the MC line at two different points.

Identifying Profit-Maximizing Quantity (Q*)

  • First Intersection: Typically skipped; the firm is just starting.
  • Second Intersection: Focus on this for profit maximization.
    • For a quantity of 40, MC is $19.23, which is less than MR ($20). Production continues.
    • For a quantity of 54, MC is $17.86, continue production.
    • For a quantity of 66, MC is $20.83, which exceeds MR, so stop producing.
  • Q = 54 units* (profit-maximizing quantity).

Step 2: Determine Profit Maximizing Price

  • Profit Maximizing Price: Given as $20.

Step 3: Average Total Cost (ATC)

  • ATC = $32.40.
  • Profit or Loss: Since ATC > Price, the firm incurs a loss.
    • Loss occurs when ATC is greater than Price.

Decision to Shut Down or Continue

  • Average Variable Cost (AVC = $23.15): Comparisons are made.
  • Shut Down Condition: If Price < AVC, the firm should shut down. Here, AVC < Price, so the firm continues operating but incurs losses.

Practice Problem 32

  • New market price = $25.
  • Follow similar steps:
    • Identify Q* and stop at the second intersection.
    • Explore quantities until MC exceeds MR.
    • Identify Q* = 76 units.
    • ATC = $29.61, which is greater than price; the firm incurs losses but continues operating since AVC < Price.

Practice Problem 33

  • Market Price = $36.
  • Identify Q* and follow steps:
    • Continue producing until MC exceeds MR.
    • Profit maximizing Q = 91 units, with Price = $36.
    • ATC < Price, leading to positive profits.

Conclusion

  • The five-step pattern for maximizing profits is consistent regardless of whether using graphical illustrations or specific numerical data.
  • Emphasize practice with both methods.
  • Upcoming discussion will transition from short-run to long-run analysis.