ECON 1201 Lecture Notes - Lecture 20: Taipei Metro, Marginal Revenue, Profit Maximization
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November 1, 2018
Chapter 12
Explaining the Optimal Output Rule
● Why is profit maximized where MR = MC?
● Each time the firm produces another unit, there are extra costs and extra
revenues
● If producing another unit adds more to the revenue than cost, profit will increase
○ Because if MR>MC, producing more will add to profit
○ And if MR< MC, producing less will add to profit
● Since MR= P for competitive firms, the profit-maximizing rule is: Choose the
quantity of output where P = MC
Costs and Production in the Short-Run
● As long as increasing production by one more unit creates more MR than MC, it
makes sense to do it
● Reminder: in the short-run, plant size is fixed
○ We focus here on short run profit maximization at a given plant size
● If the price is just high enough to cover ATC and if it chooses the Q where
○ MR = MC, the firm will break even
Pitfalls
● What if marginal revenue and marginal cost aren’t exactly equal?
● What do you do if there is no output level at which marginal revenue equals
marginal cost?
○ In that case, you produce the largest quantity for which marginal
revenue exceeds marginal cost.
When is Production Profitable?
● Recall we are using economic profit, which includes implicit costs. It is normal for
a firm’s economic profit to be zero
○ If TR>TC, the firm is profitable
○ If TR=TC, the firm breaks even
○ If TR<TC, the firm incurs a loss
Calculating Total Costs and Profit
● Profit = TR - TC = (TR/Q - TC/Q) x Q
○ Or Profit = (P - ATC) X Q
Document Summary
Each time the firm produces another unit, there are extra costs and extra revenues. If producing another unit adds more to the revenue than cost, profit will increase. Because if mr>mc, producing more will add to profit. And if mr< mc, producing less will add to profit. Since mr= p for competitive firms, the profit-maximizing rule is: choose the quantity of output where p = mc. As long as increasing production by one more unit creates more mr than mc, it makes sense to do it. Reminder: in the short-run, plant size is fixed. We focus here on short run profit maximization at a given plant size. If the price is just high enough to cover atc and if it chooses the q where. Mr = mc, the firm will break even. In that case, you produce the largest quantity for which marginal revenue exceeds marginal cost. Recall we are using economic profit, which includes implicit costs.
