Lecture on Profit Maximization in Competitive Markets

Key Concepts

• Competitive Market: Firms have no control over prices; must accept the market price.
• Profit: Calculated as total revenue minus total cost.
  • Total Revenue (TR): Price multiplied by quantity sold.
  • Total Cost (TC): Sum of fixed costs and variable costs.

Types of Costs

• Fixed Costs: Costs that do not vary with output.
  • Example: Rental cost for land.
  • Opportunity Cost: The cost of forgoing the next best alternative.
    • Economic profit includes opportunity costs, unlike accounting profit.
• Variable Costs: Costs that vary with output.
  • Examples: Electricity for operations, transportation costs.

Profit Maximization

• Objective: Choose the quantity of output that maximizes profit.
• Profit Equation: Profit = TR - TC
• Calculus Method: Maximize function by setting derivative of profit with respect to quantity to zero.
  • Marginal Revenue (MR): Change in total revenue from selling an additional unit.
  • Marginal Cost (MC): Change in total cost from producing an additional unit.
  • Profit is maximized when MR = MC.

Intuitive Explanation

• Compare additional revenues and costs for decision making.
  • If MR > MC: Produce more to increase profit.
  • If MR < MC: Produce less to increase profit.
• Profit Maximization Condition: MR = MC

Diagram Explanation

• Competitive Firm: Small relative to market; MR equals market price.
• Marginal Cost Curve: Typically upward-sloping.
  • Costs increase with higher production due to limitations.
• Profit Maximizing Point: When price (MR) equals MC.

Firm Behavior and Market Price

• Changes in market price affect firm production level.
  • Example: Market price $50 = optimal output 8 barrels.
  • Price increase to $100 = increase output to just under 10 barrels.

Profit and Loss

• Even at profit-maximizing levels, firms can incur losses.
• Average Cost (AC): Total cost divided by quantity.
  • AC curve helps determine the size of profits or losses.

Next Steps

• Future discussion on illustrating profit and loss on the diagram using the average cost curve.