AP Micro: Lesson 3.5 - Profit Maximization

How do you calculate economic profit?

TR - TC

How do you calculate TR?

TR = P • Q

What does breaking even mean?

Making normal profit. Economic profit = 0

Is breaking even a bad thing for a firm? Explain

No. It means a firm is doing just as well operating the business as they would doing another job

No other job will make you do as well as you are doing now

How do you find the optimal quantity using total benefit vs. TC?

Total benefit = TR for producers

Optimal choice is when difference between TR (total benefit) and TC is the greatest (TR > TC)

How do you find the optimal quantity using MB vs. MC?

MB = marginal revenue for producers

Optimal choice is when MB = MC

What is marginal revenue (MR)? and formula

The additional revenue from selling an additional unit of output

MR = change TR ÷ change Q

MR is the derivative of TR (tracks the slope)

What does MR look like when demand is perfectly elastic?

MR is perfectly elastic (same as demand)

What does MR look like when demand is downward sloping?

It is a decreasing line (goes negative when TR decreases)

What is the relationship between price and demand?

Demand = price

Define average revenue (and formula)

AR = TR ÷ Q

What is the relationship between P and AR?

P = AR

TR = P • Q, so P = TR ÷ Q (same as AR: AR = TR ÷ Q)

Explain D = AR = P

Occurs when demand is downward sloping

D = P
AR = TR ÷ Q
P = TR ÷ Q

So... D = AR = P

Explain MR = D = AR = P

Occurs when D is perfectly elastic

MR is perfectly elastic when D is perfectly elastic, so MR = D
D = P
P = TR ÷ Q
AR = TR ÷ Q

So... MR = D = AR = P

How is MR vs MC similar to MB vs MC? How do you find the optimal choice using MR vs. MC?

MR = MB for producers. They are the same thing

Optimal choice when MR = MC (profit-maximizing rule)