PROFIT MAXIMIZATION AND PERFECT COMPETITIONSUBMITTED TO :DR Sabahat

SUBMITEED BY : Javeria gul Zaheer abbas

Subject :Micro Economics Department of Economics NUML Islamabad

PROFIT MAXIMIZATION

A cost curve describes the minimum cost at which a firm can produce various amount of output.

A perfectly competitive firm is presumed to produce the quantity of output that maximizes economic profit--the difference between total revenue and total cost revenue and marginal cost.

This production decision can be analyzed directly with economic profit, by identifying the greatest difference between total revenue and total cost, or by the equality between marginal

To obtain the profit maximizing output quantity, we start by recognizing that profit is equal to total revenue (TR) minus total cost (TC). Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph. The profit-maximizing output is the one at which this difference reaches its maximum.

MARGINAL REVENUE, MARGINAL COST, AND PROFIT MAXIMIZATION

Profit equals total revenue minus total cost. Given businesses want to maximize profit, they should keep producing more output as long as an additional unit adds more to revenue than it adds to cost.

Economists call the added revenue marginal revenue and the added cost marginal cost. Thus, firms should continue producing more output until marginal revenue equals marginal cost. That’s the point where profits are maximized. Marginal revenue (MR), the increase in total revenue for production of one additional unit, will always be equal to the market price for a price taker.

If the market price of a good is Rs15, and a firm produces 10 units of a good per day, then its total revenue for the day will be Rs15 × 10 = Rs150. The marginal revenue associated with producing an eleventh unit per day would be the market price, Rs15; total revenue per day would increase from Rs150 to Rs165 (11 × Rs15).

Marginal costs will vary, depending upon the quantity produced. We would expect the firm to increase input up to the point where marginal cost is equal to the market price. In the short run, a firm will produce as long as its average variable costs do not exceed the market price. If the market price is less than the firm's total average cost, but greater than its average variable cost, then the firm will still operate in the short run.  π = MR = MC

Marginal Cost-Marginal Revenue Perspective

Firms will produce up until the point that marginal cost equals marginal revenue. This strategy is based on the fact that the total profit reaches its maximum point where marginal revenue equals marginal profit .

MR= MC curve

This is the case because the firm will continue to produce until marginal profit is equal to zero, and marginal profit equals the marginal revenue (MR) minus the marginal cost (MC) Another way of thinking about the logic is of producing up until the point of MR=MC is that if MR>MC, the firm should make more units: it is earning a profit on each. If MR<MC, then the firm should produce less: it is making a loss on each additional product it sells.

SHORT RUN PROFIT MAXIMIZATION

In the short run a firm operates with a fixed amount of capital and must choose the levels of its variable inputs (labor and materials) to maximize profit. The average and marginal revenue curves are drawn as a horizontal line at a price equal to Rs 40. we have drawn the average total cost curve AC , and the marginal cost curve MC so that we can see the firm’s profit more easily.

Short- run profit maximization

Profit is maximized at point A, where output is q* =8 and the price is Rs 40 because marginal revenue is equal to marginal cost at this point. To see that q* =8 is indeed the profit maximizing output, note that a lower output say q1=7 marginal revenue is greater than marginal cost ; profit could thus be increased by increasing output. The shaded area between q1=7and q* shows the lost profit associated with producing at q1. at a higher output say q2 MC>MR thus reducing output saves a cost exceeds the reduction in revenue. The shaded area between q* and q2=9 shows the lost profit associated with producing at q2.

In the short run the competitive firm maximizes its profit by choosing an output q* at which its marginal cost is equal to the price P or MR = MC at quantity, q*, of 8 At a quantity less than 8, MR > MC, so more profit can be gained by increasing output. The profit of the firm is measured by the rectangle ABCD. Any change in output, whether lower at q1 or higher at q2 , will lead to lower profit.

The short run market supply curve

The short-run market supply curve shows the amount of output that the industry will produce in the short run for every possible price. The industry’s output is the sum of the quantities supplied by all of its individual firms. Therefore the market supply curve can be obtained by adding the supply curves of each of these firms. There are only three firms, all of which have different short run production costs.

THE SHORT-RUN MARKET SUPPLY CURVE

The short run market supply curve

The firm’s marginal cost curve is drawn only for the portion that lies above its average variable cost curve. At any price below p1, the industry will produce no output because p1 is the minimum average variable cost of the lowest cost firm. Between p1 and p2 only firm 3 will produce. At p2 the industry supply will be the sum of the quantity supplied by all three firms.firm1 supplies 2 units and firm 2 supplies 5 units, and firm 3 supplies 8 units. Industry supply is thus 15 units. At price p3 firm 1 supplies 4 firm 2 is 7 and firm 3 supplies 10 units, the industry supplies 21 units.

The short-run market supply curve shows the amount of output that the industry will produce in the short run for every possible price.

The short-run industry supply curve is the summation of the supply curves of the individual firms. Because third firm has a lower average variable cost curve then the first two firms, the market supply curve S begins at price P1 and follows the marginal cost curve of the 3rd firm MC3 until price equals P2.

Producer surplus in the short run

The producersurplus for afirm is measuredby the shaded areabelow the market price and above themarginal cost curve,between output 0 and q* the profitMaximizing output.It is equal to rectangleABCD.

Producer surplus in the short run

The graph illustrates short run producer surplus for a firm. The profit maximizing output is q* where P=MC. The surplus that the producer obtain from selling each unit is the difference between the price and MC of producing the unit. The producer surplus is then the sum of these unit surpluses over all the units that the firm produces. When we add the marginal cost of producing each level of output from 0 to q* , we fined that the sum is the total variable cost of producing q*.

PRODUCER SURPLUS FOR A MARKET

The producerSurplus for aMarket is the areaBelow the marketprice and aboveThe market supplyCurve, 0 and output Q.