KNOW

UNDERSTAND

The profit maximising position for a PC and A MonopolistEquilibrium output taking a marginal analysis approach

How to illustrate the profit maximising position for both PC and MonopolyDecisions of firms using a marginal approach when there are price changes

THINKING – MANAGING SELF – PARTICIPATING AND CONTRIBUTING - RELATING TO OTHERS – USING LANGUAGE, SYMBOLS and TEXT

LEVEL 3 ECONOMICS AS3.1 Understand marginal analysis and the behaviour of firms

Understanding Economics Chapt 9, P80-99

Marginal Analysis - Equilibrium

PRICECOSTREVENUE

QUANTITY

A Perfect Competitor

MC

MR

Recall that a perfect competitor faces a perfectly elastic demand curve

where D = P = AR = MR (if you can’t explain why return to CHAPT 4 in your workbook)

PRICECOSTREVENUE

QUANTITY

A Perfect CompetitorMC

MR

We can now illustrate on the graph of a perfect competitor both an MC curve and an MR curve. A PC is said to be in equilibrium when it is producing at its profit maximising position.

RULE: where MC = MR a firm will maximise its profits

WHY

Think again about MARGINAL concepts

If MR is the addition to revenue when we sell one more unit and MC is the addition to cost when we make one more unit then it follows that

MR minus MC is the addition to profit when we produce/sell one more unit?

Example if the MR we gain from the last unit sold is $5 and that unit cost us $4 to make then we added $1 to whatever profit we had made to that point.

If you have a question post them on the discussion group now or see me

Then if the last unit contributed an extra dollar to profit we should make and sell a another unit because that too might contribute more to profit?

Agree?

Marginal Analysis

If you agree so far you will accept then that the PC should keep producing units of output until MC = MR. That is the PROFIT MAXIMISING level of output.

If MC < (less than) MR a PC should increase production because there may be more profit to be added

If MC > (greater than) MR a PC should cut back production because making these units leads to a negative marginal profit which takes away from the profit made to that point.

THEREFORE the Profit Max point is where MR = MC.(That is the key to understanding marginal analysis.)

PRICECOSTREVENUE

QUANTITY

A Perfect Competitor

MC

MR

Qmax

MR is equal to MC at a quantity of Qmax (another way of saying the profit maximising quantity of output) and price Pe

Pe

PRICECOSTREVENUE

QUANTITY

A Perfect Competitor

MC

MR

Qmax

At a quantity of Q1 you will see that the P (MR) received for that unit is higher than what the unit costs to make. Because we are talking marginal, that unit contributes to accumulated profits to date. The PC should keep producing beyond Q1

Q1

MC1

Pe

PRICECOSTREVENUE

QUANTITY

A Perfect Competitor

MC

MR

Qmax

At a quantity of Q2 you will see that the P (MR) received for that unit is lower than what the unit costs to make. Because we are talking marginal, that unit contributes negatively to accumulated profits to date. The PC should lower their output below Q2

Q2

MC2

Pe

PRICECOSTREVENUE

QUANTITY

MR

A MonopolyMC

The same rule applies to a Monopoly. Recall the revenue curves

D = P =AR

PRICECOSTREVENUE

QUANTITY

MR

A Monopoly

MC

D = P =AR

A Monopoly maximises its profit at the output quantity where MR = MC. The reason is exactly the same as for the PC. Notice that at Qmax the dotted line runs up through the point where MC crosses MR (where they are equal) all the way to the demand curve. The Monopoly is in equilibrium at a combination Pe and Qmax.

Qmax

Pe

Open an email in your own email service and answer the following question:

Explain why a PC maximises profit at the level of output where MR = MC. By the way, the same rule is also true for a Monopolist.

Send your email to me at chrisbell1cb@gmail.com