Profit and Supply

1
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

2
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 lt 0 if a firm increases production then
  the price will fall
• ?(q) TR(q) TC(q)
• ?(q) P(q)q TC(q)

3
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

4
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

5
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

6
Example

• Demand
• P 10 Q
• TR PQ 10Q Q2
• 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)

7
MR

• MR P(11/e)
• If e lt -1 (elastic) then MR lt 0
• If -1 lt e lt 0 then MR gt 0
• If e -1 the MR 0

8
Profit Max e

• MC MR
• MC P(11/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 -8 then PMC

9
Short-Run Supply

• Firm will choose level of output such that MR
  MC
• If P MR then P MC
• If P lt min AVC then choose Q 0
• Graphical examples
• Numeric examples

10
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