Profit Maximization Module KRUGMAN'S MICROECONOMICS for AP* 17 53 Margaret Ray and David Anderson

What you will learn in this Module: The principle of marginal analysis. How to determine the profit-maximizing level of output using the optimal output rule. The purpose of this module is to go from the definition of economic profit to the goal of the firm: to maximize economic profit. Students will see that the profit-maximizing level of output is found at the quantity where the marginal revenue is equal to marginal cost.

Profit Maximization Both TR and TC are functions of output. As more output is sold (at a constant price), TR and TC both rise. The goal of the firm is to find the level of output where the economic profit is greatest (maximized).

Marginal Analysis MR = ΔTR/∆Q MC = ΔTC/∆Q Marginal revenue is the additional revenue from selling one more unit of output. MR = ΔTR/∆Q Marginal cost is the additional cost incurred from producing one more unit of output. MC = ΔTC/∆Q Firms will continue to produce as long as MR > MC and will stop producing when MC = MR If the additional dollars coming into the firm as revenue outweigh the additional dollars going out as cost, should the firm produce an additional unit of output? The answer is “yes”. Two important concepts to introduce:   Marginal Revenue = MR = (Change in Total Revenue)/(Change in Output) Marginal Cost = MC = (Change in Total Cost)/(Change in Output) If output is changing one unit at a time: MR = ΔTR, and MC = ΔTC Firms will continue to produce as long as MR > MC. They will stop producing, because they have produced all units that earn them profit (i.e. where MR > MC) when MC = MR. This is the profit maximization rule.

The Optimal Output Rule MR = MC stop at the hospital MC = MR is the optimal output rule for profit maximization and one of the cornerstone results in microeconomics. The students will be tested on this concept in multiple ways.

Graphical Representation of Profit Maximization

When is Production Profitable? So long as economic profit is greater than or equal to zero, the firm should continue to operate. If economic profits dip below zero (i.e. below a normal profit), the firm would consider permanently closing and moving resources to their next best alternative.