22_Econ8e_PPT_Ch22

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Profit maximization : 

Profit maximization Chapter 22 Economics, 8th Edition Boyes/Melvin

Profit Maximization : 

Profit Maximization The objective of a for-profit firm is to maximize profit. Profit is total revenue less the costs of the resources (land, labor, capital) used. Total revenue is the price of goods and services multiplied by the quantity sold, PQ. Profit = PQ – Cost of land, labor and capital 2 Copyright © Cengage Learning. All rights reserved.

Marginal Revenue and Marginal Cost : 

Marginal Revenue and Marginal Cost The profit maximizing quantity of output can be determined by comparing marginal revenue and marginal cost. Marginal cost is the additional cost of producing one more unit of output. Marginal revenue is the additional revenue from selling one more unit of output. Profit is maximized at the output level where marginal revenue and marginal cost are equal. The supply rule is: Produce and offer for sale the quantity at which MR=MC. 3 Copyright © Cengage Learning. All rights reserved.

MR and MC : 

MR and MC Marginal Revenue = Change in Total Revenue/Change in Total Output MR = ΔTR/ΔQ Marginal Cost = Change in Total Cost/Change in Total Output MC = ΔTC/ΔQ Comparing marginal revenue and marginal cost determines whether the firm needs to supply more or less in order to maximize profit. 4 Copyright © Cengage Learning. All rights reserved.

Profit maximization : 

Profit maximization 5 Copyright © Cengage Learning. All rights reserved.

Profit Maximization : 

Profit Maximization 6 Copyright © Cengage Learning. All rights reserved.

Market Structure : 

Market Structure The selling environment in which a firm produces and sells its product is called a market structure. Defined by three characteristics: The number of firms in the market The ease of entry and exit of firms The degree of product differentiation 7 Copyright © Cengage Learning. All rights reserved.

Characteristics of market structures : 

Characteristics of market structures 8 Copyright © Cengage Learning. All rights reserved.

Perfect Competition : 

Perfect Competition Perfect Competition is a market structure characterized by: Many large firms, so large that no one firm has the ability to affect the market. These firms are price takers—they have to go along with the market price. Identical products – the products are perfect substitutes. Easy entry into the industry. The demand curve is horizontal. 9 Copyright © Cengage Learning. All rights reserved.

Perfect Competition : 

Perfect Competition 10 Copyright © Cengage Learning. All rights reserved.

Monopoly : 

Monopoly Monopoly is a market structure in which thereis just one firm, and entry by other firms is not possible. There are no close substitutes. The firm has the power to set the price, but still sets an optimal price to maximize profit. If the monopolist sets the price too high, revenue will decline. The firm is a price maker. The firm’s demand curve is the market demand curve, and it is downward sloping. 11 Copyright © Cengage Learning. All rights reserved.

Monopoly : 

Monopoly 12 Copyright © Cengage Learning. All rights reserved.

Monopolistic Competition : 

Monopolistic Competition Monopolistic Competition is characterized by: A large number of firms Easy entry Differentiated products -- because each firm’s product is slightly different, each firm is kind of a mini-monopoly—the only producer of that specific product. This allows the firm to be a price maker. The firm’s demand curve is downward sloping and depending on the differentiation of the firm’s product, it may be fairly inelastic. 13 Copyright © Cengage Learning. All rights reserved.

Monopolistic Competition : 

Monopolistic Competition 14 Copyright © Cengage Learning. All rights reserved.

Oligopoly : 

Oligopoly Oligopoly is characterized by: Few firms—more than one, but few enough so each firm alone can affect the market. Entry is more difficult, but can occur. The firms are interdependent—each is affected by what others do. The demand curve is downward sloping for each firm, but its shape depends on the behavior of competitors. 15 Copyright © Cengage Learning. All rights reserved.

Summary of Market Structures : 

Summary of Market Structures 16 Copyright © Cengage Learning. All rights reserved.

Accounting Profit : 

Accounting Profit The profit figure reported in annual reports and income statements is accounting profit: Accounting Profit = PQ – (cost of land) - (cost of labor) – (cost of capital) 17 Copyright © Cengage Learning. All rights reserved.

Economic Profit : 

Economic Profit Accounting profit does not include the cost of ownership – called equity capital. Economic profit includes all opportunity costs. Economic profit = accounting profit – cost of equity capital 18 Copyright © Cengage Learning. All rights reserved.

Economic Profit : 

Economic Profit Economists refer to a firm that subtracts value, whose cost of equity capital is greater than its accounting profit, as having negative economic profit. A firm that neither adds value nor subtracts it is a firm whose revenue is sufficient to pay the costs of inputs, but generates nothing in excess of this. This result is referred to as zero economic profit. If a firm is returning more to its owners than the owners’ opportunity cost, the firm is said to be earning a positive economic profit. 19 Copyright © Cengage Learning. All rights reserved.

Role of Economic Profit : 

Role of Economic Profit Economic profit operates as a coordinating factor in the economy. When a firm earns a positive economic profit, investors in the firm are earning better returns than they normally would with competing investments. Other investors will want to invest in firm, too. As a result, resources will flow to where they earn more. 20 Copyright © Cengage Learning. All rights reserved.

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