3.2 Profit maximization and the competitive firm's supply curve
4 min read•august 16, 2024
is key for competitive firms. They produce where price equals , following the upward-sloping part of their marginal cost curve. This rule helps firms decide how much to make in both short and long run.
A firm's comes from its marginal cost curve. In the short run, it's the part above average . Long-term, it's above long-run average costs. Understanding this helps explain how firms and industries respond to price changes.
Profit Maximization for Competitive Firms
Profit Maximization Rule
Top images from around the web for Profit Maximization Rule
Production Decisions in Perfect Competition | Boundless Economics View original
Is this image relevant?
Production Decisions in Perfect Competition | Boundless Economics View original
Is this image relevant?
Profit Maximization in a Perfectly Competitive Market | Microeconomics View original
Is this image relevant?
Production Decisions in Perfect Competition | Boundless Economics View original
Is this image relevant?
Production Decisions in Perfect Competition | Boundless Economics View original
Is this image relevant?
1 of 3
Top images from around the web for Profit Maximization Rule
Production Decisions in Perfect Competition | Boundless Economics View original
Is this image relevant?
Production Decisions in Perfect Competition | Boundless Economics View original
Is this image relevant?
Profit Maximization in a Perfectly Competitive Market | Microeconomics View original
Is this image relevant?
Production Decisions in Perfect Competition | Boundless Economics View original
Is this image relevant?
Production Decisions in Perfect Competition | Boundless Economics View original
Is this image relevant?
1 of 3
Profit maximization rule dictates producing at output level where (MR) equals marginal cost (MC)
In perfectly competitive markets, price equals marginal revenue for all units sold (firms are price takers)
Profit-maximizing condition expressed as P=MR=MC, where P represents market price
Firms should increase production when MR>MC and decrease when MR<MC to maximize profits
Second-order condition for profit maximization requires MC curve slope to exceed MR curve slope at intersection point
Rule applies to both short-run and long-run decision-making for competitive firms (wheat farmers, small retail stores)
Profit Maximization Analysis
Analyze firm's cost structure including (rent, equipment) and variable costs (labor, raw materials)
Determine market price for the product (set by market forces in competitive markets)
Calculate marginal revenue which equals market price in
Compute marginal cost at different output levels
Identify output level where MR=MC on the upward-sloping portion of MC curve
Verify second-order condition satisfied ensuring profit maximum rather than minimum
Supply Curve Derivation for Competitive Firms
Short-Run Supply Curve
Competitive firm's supply curve derived from portion of marginal cost curve above average variable cost (AVC) curve
occurs where marginal cost curve intersects AVC curve at its minimum point
Firm's supply curve starts at shutdown point and follows upward-sloping portion of marginal cost curve
Zero output produced at prices below shutdown point in short run
Supply curve elasticity depends on marginal cost curve shape (steeper MC curve leads to less elastic supply)
decisions influenced by fixed costs (factory rent) and variable costs (labor, materials)
Long-Run Supply Curve
Long-run supply curve derived from portion of (LRMC) curve above (LRAC) curve
Entry and exit of firms affects long-run industry supply
Perfectly elastic long-run supply curve in constant-cost industries (identical cost structures for all firms)
Upward-sloping long-run supply curve in increasing-cost industries (resource scarcity or differences in firm efficiencies)
Downward-sloping long-run supply curve in decreasing-cost industries (economies of scale at industry level)
Long-run adjustments include changes in plant size, technology adoption, and resource allocation
Price, Marginal Revenue, and Marginal Cost
Relationships in Competitive Markets
Price remains constant and equal to marginal revenue for all units sold in perfectly competitive markets
Marginal cost curve typically U-shaped due to law of diminishing marginal returns
Firm's occurs where horizontal price line intersects upward-sloping portion of marginal cost curve
Market price changes lead to movements along firm's marginal cost curve affecting optimal output level
Area between price line and marginal cost curve represents firm's
Price elasticity of supply determined by relationship between price changes and quantity supplied changes along marginal cost curve
Graphical Analysis
Plot price as horizontal line on graph (perfectly elastic demand for individual firm)
Draw U-shaped marginal cost curve
Identify intersection point of price line and marginal cost curve
Shade area between price line and marginal cost curve to visualize producer surplus
Illustrate how price changes shift optimal output level along marginal cost curve
Demonstrate supply curve derivation by tracing firm's responses to different price levels
Short-Run Profit Maximization for Competitive Firms
Determining Optimal Output
Identify profit-maximizing output level where P=MC on upward-sloping portion of marginal cost curve
Ensure chosen output level satisfies shutdown condition by being above average variable cost curve
Calculate total revenue (TR) by multiplying market price by quantity produced at optimal output level
Compute total cost (TC) by adding fixed costs to area under marginal cost curve up to optimal output level
Determine firm's economic profit or loss by subtracting total cost from total revenue (π=TR−TC)
Compare profit-maximizing output level to break-even point (P=ATC) and shutdown point to assess firm's short-run operating decision
Profit Analysis and Decision Making
Evaluate different scenarios based on market price levels (high profit, normal profit, loss-minimizing, shutdown)
Calculate profit or loss at various output levels to verify profit maximization
Analyze impact of cost changes (input prices, technology) on profit-maximizing output and overall profitability
Consider short-run alternatives like temporarily suspending production if price falls below average variable cost
Assess implications of operating at a loss in short run (covering variable costs but not all fixed costs)