1. MODULE 53: PROFIT MAXIMIZATION
Duffka School of Economics
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2. Key Economic Concepts For This Module:
• Economic profit is equal to total revenue minus total cost. • The firm’s goal is to choose the level of output that maximizes economic profit. • Marginal analysis shows us that the profit-maximizing level of output is where marginal revenue equals marginal cost (MR(MB)=MC).
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3. Presentation Format
I. Maximizing Profit A. Using Marginal Analysis to Choose the Profit-Maximizing Quantity of Output B. When is Production Profitable?
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4. I. Maximizing Profit
The previous module defined economic profit as the difference between total revenue and total cost. Π(profit) = TR – TC = P*Q - TC Both TR and TC are functions of the quantity of output. As more output is sold (at a constant price), total revenue rises, but so too does total cost. The goal of the firm is simple: find the level of output where the economic profit is the greatest (or maximized).
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5. I. Maximizing Profit
A. Marginal Analysis to Choose the Profit-Maximizing Quantity of Output The lemonade stand could make their profit maximizing output decision on an incremental, or marginal, basis “Should we produce the next cup of lemonade?” If the additional dollars coming into the firm as revenue outweigh the additional dollars going out as cost, the answer is “yes”. Two important concepts: 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
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6. I. Maximizing Profit
A. Marginal Analysis to Choose the Profit-Maximizing Quantity of Output Text Example:
P X Q=TR
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7. I. Maximizing Profit
A. Marginal Analysis to Choose the Profit-Maximizing Quantity of Output Text Example:
Profit Maximization
MR(MB)>MC
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8. I. Maximizing Profit
MR>MC—Profit maximization occurs as MR gets as close to equal to MC as possible.
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9. I. Maximizing Profit
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10. Mr. Clifford
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11. B. When is Production Profitable?
So long as economic profit is greater than or equal to zero, the firm should continue to operate.
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12. Is Profit Good? Profit derived from selling us what we are willing to buy must be good.
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13. Is Profit Good?
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14. Practice Question #1
$18
1. What is the marginal revenue of the third unit of output? a. $8 b. $14 c. $18 d. $44 e. $54
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15. Practice Question #2
2. What is the marginal cost of the first unit of output? a. $0 b. $14 c. $16 d. $18 e. $30
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16. Practice Question #3
$18
$16
$18 $6
$18 $8
$18
$12
$18
$16
$22
$18
$25
$18
3. At what level of output is profit maximized? a. 0 b. 1 c. 3 d. 5 e. 7
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17. Practice Question #4
4. A firm should continue to produce as long as its a. total revenue is less than its total costs. b. total revenue is greater than its total explicit costs. c. accounting profit is greater than its economic profit. d. accounting profit is not negative. e. economic profit is at least zero.
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18. Practice Question#5
5. A firm earns a normal profit when its a. accounting profit equals 0. b. economic profit is positive. c. total revenue equals its total costs. d. accounting profit equals its economic profit. e. economic profit equals its total explicit and implicit costs.
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