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TR, TC

and profit graphically

Marginal m

ethod for maxim

izing profit

• Put M

C and M

R together

• Have from

perfect competition and the

market price the M

R curve (horizontal)

• And have the M

C curve shape from

the previous chapter

MR

, MC

and profit maxim

ization graphically

What w

e just did: the general rule

– If MR

> MC

, the extra revenue from

selling one more unit exceeds the extra

cost incurred to produce it. – E

conomic profit increases if output

increases.

– The opposite holds if MC

> MR

.

First decision made: found the

profit maxim

izing level of output

This is the best the firm can do.

But, is it good enough?

What is profit at this profit m

aximizing

point?

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The second decision: stay open or shut dow

n

• Temporary S

hutdown D

ecisions – If a firm

is incurring an economic loss that

it believes is temporary, it w

ill remain in the

market, and it m

ight produce some output

or temporarily shut dow

n.

Why fixed and variable costs are

important

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Decision rule for shutting dow

n

So the firm

produces some output if P > AV

C

but shuts down tem

porarily if AVC

> P

Because by producing any output at all it

increases its losses.

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What if econom

ic profit > 0?

Happens because P > ATC

at level of output w

here P (MR

) = MC

. W

hat does this signal to other potential firm

s? H

ow does this lead to econom

ic profit in com

petition always = 0?

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Role of entry and exit

– The imm

ediate effect of the decision to enter or exit is to shift the m

arket supply curve.

– If more firm

s enter a market, supply

increases and the market supply curve

shifts rightward.

– If firms exit a m

arket, supply decreases and the m

arket supply curve shifts leftw

ard.

Dem

and also plays a role

– A decrease in demand triggers a sim

ilar response, except in the opposite direction.

– The decrease in demand brings a low

er price, econom

ic loss, and some firm

s exit.

– Exit decreases m

arket supply and eventually raises the price to its original level.

The role of technology: two forces

1. Firms that adopt the new

technology make

an economic profit.

New

-technology firms have an incentive to

enter. 2. Firm

s that stick with the old technology

incur economic losses.

These firms either exit the m

arket or switch

to the new technology.