CDAE 254 - Class 21 Nov. 6

Last class: Result of Quiz 5 6. Costs

Today: 7. Profit maximization and supply Quiz 6 (chapter 6)

Next class: 7. Profit maximization and supply

Important date:Problem set 6: due Thursday, Nov. 15

(Problems 6.1., 6.4., 6.6., 6.9., and 6.10 from the textbook)

6. Costs6. Costs

6.1. Basic concepts of costs

6.2. Cost minimizing input choice

6.3. Cost curves

6.4. Short-run and long-run costs

6.5. Per unit short-run cost curves

6.6. Shifts in cost curves

6.7. An example

6.8. Applications

7. Profit maximization and supply

7.1. Goals of a firm

7.2. Profit maximization

7.3. Marginal revenue and demand

7.4. Marginal revenue curve

7.5. Alternatives to profit maximization

7.6. Short-run supply

7.7. Applications

7.1. Goals of a firm

-- Maximize profit

-- Maximize TR to increase market shares

-- Maximize the utility of the manager

-- Maximize the expected profit and reduce the risk

…..

7.2. Profit maximization

-- Profit = TR – TC = Pq – TC

-- A graphical analysis (TR, TC and ) (Fig. 7.1)

-- is at the maximum level when the slope of the profit curve is equal to zero

Slope of the total profit = M = 0

“M = 0” is equivalent to “MR=MC”

i.e., when the slope of the TR curve is equal to the slope of the TC curve

7.2. Profit maximization

-- Conclusion: is at the maximum level when

MC=MR

-- Why is this the decision rule?

If MR > MC, can be increased by increasing q

If MR < MC, can be increased by decreasing q

If MR = MC, can not be increased

7.3. Marginal revenue and demand

-- A small firm vs. a large firm:

A small firm (price taker): A firm whose decisions regarding selling do not affect

the market price of the good.

A large firm: A firm whose decisions regarding selling do affect the market

price of the good.

7.3. Marginal revenue and demand

-- Marginal revenue of a small firm: MR = P

-- Marginal revenue of a large firm: -- A downward-sloping demand curve: when the firm wants to sell more, it has to reduce the price.

-- MR < P

e.g., a firm has the demand function of

q = 10-P.

When P = 7, q = 3, TR = $21. If the firm wants to sell 4 units, P = 6 and TR = $24. What is the MR of this last unit?

7.3. Marginal revenue and demand

-- Example

Demand function q = 10 - P

TR and MR (Table 7.2 and Fig. 7.3)

-- Price elasticity of demand and MR:

-- Price elasticity of demand:

-- Range of price elasticity of demand:

< -1 elastic

= -1 unit elastic

> -1 inelastic

Pin change %

qin change %, Pqe

7.3. Marginal revenue and demand

-- Price elasticity of demand and MR:

< -1 elastic MR > 0

= -1 unit elastic MR = 0

> -1 inelastic MR < 0

-- Summary:

PqePMR

,

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7.4. Marginal revenue curve

-- Marginal revenue curve: Relationship between MR and output level (q)

-- MR curve of a small firm (price taking firm):

MR=P

-- MR curve of a large firm with a downward- sloping demand curve:

-- Table 7.1 and Fig. 7.2

-- Fig. 7.3.

Class exercise

Suppose that the demand function for a company’s product is estimated as q = 8 - 0.5 P where q is the quantity and P is the price.

(1) Draw the demand curve

(2) Derive the MR function and draw the MR curve

(3) What is the price elasticity of demand when P=4?

(4) If the company wants to increase its market share, should it increase or decrease its price?