Profit and Supply Economic profit compared with accounting profit Economic costs = explicit costs + implicit costs Accounting profit = TR – Explicit Costs = Net operating revenue Economic profit = TR – Explicit Costs – Implicit Cost

Total Revenue & Profit TR(q) = P(q) x q In this case P(q) says that the market price is related to the quantity produced dP/dq < 0 : if a firm increases production then the price will fall Π(q) = TR(q) – TC(q) Π(q) = P(q)q – TC(q)

First Order Conditions A firm will choose q such that MR = MC TR’ = TC’ This is a general result that holds for all profit maximizing firms, both large and small

Marginal Revenue TR = P(q)q dTR/dq dP/dq x q + P(q) = dP/dq x (P/q) x P + P = P(1/e + 1) = P(1 + 1/e) e represents the “own” price elasticity of the demand curve

AR = P AR = TR/Q TR = PQ So AR = P always AR is another name for the demand curve for the product that the firm produces

Example Demand P = 10 – Q TR = PQ = 10Q – Q 2 MR = dTR/dQ = 10 – 2Q For linear (straight line) demand functions, MR will ways have the same vertical intercept as AR, but twice the slope (horizontal intercept half)

MR MR = P(1+1/e) If e < -1 (elastic) then MR < 0 If -1 0 If e = -1 the MR = 0

Profit Max & e MC = MR MC = P(1+1/e) MC/P = 1 + 1/e MC/P – 1 = 1/e 1 – MC/P = -1/e (P – MC)/P = -1/e LHS: gap between price and marginal cost (%) As demand becomes more elastic the gap between price and marginal cost closes If e = -∞ then P=MC

Short-Run Supply Firm will choose level of output such that MR = MC If P = MR then P = MC If P < min AVC then choose Q = 0 Graphical examples Numeric examples

Producer Surplus Producer surplus is the difference between total revenue and the true economic costs of production It is comprised of profit and fixed costs Measures the economic value that a firm realizes by being able to engage in market transactions