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Demand and Supply Analysis: The Firm

Q: When do we optimize output and/or maximize profit?

Profit maximization occurs when: - The difference between TR and TC is the greatest - MR equals MC - The revenue value of the output from the last unit of input employed equals the cost of employing that input unit. They all result in the same profit-maximizing output level. Note, all under perfect competition, i.e. price takers.

Q: Summary of profit-maximization and loss-minimization under perfect competition?

If TR = TC and MR > MC, operating at lower break-even point, increase Q to enter profit territory If TR>=TC and MR=MC, maximum profit level, no change to Q If TR<TC and TR>TVC, find level of Q that minimizes loss in the short run; work towards finding a profitable Q in the long run; exit market if losses continue in the long run (TFC is not fully covered). If TR<TVC, shut down production to zero, exit market in the long run TR=TC and MR<MC, operating at upper break-even point, decrease Q to enter profit territory.

7 important questions on Demand and Supply Analysis: The Firm

What is the theory of the firm?

The theory of the firm, is the study of the supply of goods and services by profit-maximizing firms. Where the theory of the consumer, was about the study of consumption, the demand for goods and services by utility maximizing individuals.

We deal with:
Profit is revenues minus costs
Revenue is price times quantity
Costs are a function of the demand and supply interactions in resource markets.

What are the bjectives of the firm?

Simply to maximize profit over the period ahead, this requires tools (optimization) and concepts (productivity). The price at which a given quantity of goods can be bought or sold is known with certainty (thereory of the firm with certainty). IF we don't make this assumption, prices and thereby profit are uncertain.

Most common objective is: shareholder wealth maximization (i.e. market value). Therefore we talk about profit.

How can a company earn an economic profit?

- Competitive advantage
- Exceptional managerial efficiency or skill
- Difficult to copy technology or innivation (patents, trademarks)
- Exclusive access to less-expensive input
- Fixed supply of an output (commodity)
- Preferential treatment under governmental policy
- Large increase in demand where supply is unable to respond fully over time
- Exertion of monopoly power (price control) in the market
- Market barriers to entry that limit competition

What are the functions of profit?

- Rewards entrepreneurs for risk taking when pursuing business ventures to satisfy consumer demand
- Allocates resources to their most-efficient use
- Spurs innovation and the development of new technology
- Stimulates business investment and economic growth

Approaches to maximize profit?
1) Difference between total revenue and total costs is the greatest
2) Comparing revenue and costs for each individual unit of output sold (per-unit revenue should exceed per-unit costs). If they breakeven, going beyond that point will decrease revenues.
3) Comparing revenues and costs for each resource unit

Summary of Revenue-Cost relationship?

If TR > TC, stay in the market in the short and long run (economic profit is being made)
If TR > TVC but TR< TFC+TVC, stay in the market in the short run but exit in the long run
If TR < TVC, shut down production to zero in the short run, exit market in the long run.

When do we optimize output and/or maximize profit?

Profit maximization occurs when:
- The difference between TR and TC is the greatest
- MR equals MC
- The revenue value of the output from the last unit of input employed equals the cost of employing that input unit.
They all result in the same profit-maximizing output level. Note, all under perfect competition, i.e. price takers.

Summary of profit-maximization and loss-minimization under perfect competition?

If TR = TC and MR > MC, operating at lower break-even point, increase Q to enter profit territory
If TR>=TC and MR=MC, maximum profit level, no change to Q
If TR<TC and TR>TVC, find level of Q that minimizes loss in the short run; work towards finding a profitable Q in the long run; exit market if losses continue in the long run (TFC is not fully covered).
If TR<TVC, shut down production to zero, exit market in the long run
TR=TC and MR<MC, operating at upper break-even point, decrease Q to enter profit territory.

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Microeconomics

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Demand and Supply Analysis: The Firm

7 important questions on Demand and Supply Analysis: The Firm

What is the theory of the firm?

What are the bjectives of the firm?

How can a company earn an economic profit?

What are the functions of profit?

Summary of Revenue-Cost relationship?

When do we optimize output and/or maximize profit?

Summary of profit-maximization and loss-minimization under perfect competition?

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