Econ Handout Goals and Market Structure (1)

Page 1: Profit Maximization

• Definition of Profit Maximization

  • Achieved when Total Revenue (TR) exceeds Total Costs (TC) by the greatest amount.

  • Identified at output level Qe where the slopes of TR and TC curves are identical and tangent lines are parallel.

• Graph Interpretation

  • Output levels below Qe:

    • Tangents diverge, indicating rising total profits; TR and TC are moving further apart.

  • Output levels beyond Qe:

    • Tangents converge, indicating a decline in profit surplus; TR is falling relative to TC.

  • Qe is the optimal output point where distance (profit) between TR and TC is maximized (AB).

  • The total profit curve shows positive profit at Q1, maximum at Qe, and negative beyond Q2.

• Marginal Revenue (MR) and Marginal Cost (MC)

  • Another depiction of profit maximization occurs where MR = MC.

  • Graphically represented at the lower level at point Qe.

  • Above Qe: Additional units add more cost than revenue; total profits decline.

  • Below Qe: Additional units add more revenue than cost; total profits increase.

Page 2: Alternative Objectives of Firms

• Sales Revenue Maximization

  • Focuses on maximizing total revenue in the short run, leading to higher output and lower prices than profit maximization.

• Growth Maximization

  • Managers aim to maximize growth in sales revenue over time.

  • Usually measured in terms of sales revenue; can also consider capital value, but this is less reliable.

• Satisficing

  • Firms pursue satisfactory profits alongside other objectives, like sales increase or market share.

  • Difficulty in defining 'satisficing' leads to challenges.

• Sales Maximization

  • Companies can experience higher output levels despite possible losses if profits from other activities cover division losses (cross-subsidization).

Page 3: Important Economic Terms

• Total Revenue (TR)

  • Aggregate revenue from sales, calculated as TR = Price x Quantity.

• Average Revenue (AR)

  • Revenue per unit sold, calculated as AR = TR/Quantity.

• Marginal Revenue (MR)

  • Additional revenue from selling one more unit; MR = change in TR/change in Quantity.

• Normal Profit

  • Minimum profit to retain resources and equal to where TR = TC (or AR = ATC).

• Abnormal Profit

  • Profit exceeding normal profit where TR > TC (or AR > ATC).

• Market Structure

  • Characteristics affecting business conduct and competition.

  • Four main types: Perfect competition, Monopoly, Monopolistic Competition, Oligopoly.

Page 4: Characteristics of Perfect Competition

• Market Composition

  • Many buyers and sellers, none can control the price.

• Nature of Product

  • Firms sell homogeneous products; branding does not influence price.

• Knowledge

  • Participants have perfect knowledge of products and pricing.

• Entry and Exit Barriers

  • Free access to the market; exit is allowed when losses occur.

• Price Control

  • Firms are price takers due to many competitors.

• Factor Mobility

  • Resources can be easily switched between product types.

Page 5: Short-Run Price and Output Decisions

• Price Determination

  • Established through the interaction of demand and supply, shown by a horizontal demand/average revenue curve.

• Profit Maximization

  • Achieved at output level where MR = MC.

  • Outputs beyond/below this point indicate losses or missed profit opportunities.

• Supernormal Profits

  • Indicated by AC curve dipping below AR; maximum profit represented by shaded area in graphs.

Page 6: Long-Run Price and Output Decisions

• Market Dynamics

  • New firms entering due to supernormal profits increase industry supply.

  • Supply curve shifts downward, establishing new equilibrium price P2.

• Impact on Output

  • Firms produce on a new demand curve D2 at an output level Q2.

  • Increases competition diminish supernormal profits, leading firms to earn only normal profit or incur losses in the long run.

Page 7: Supply Curve and Shutdown Point

• Short Run Supply Curve

  • Identified as the marginal cost curve; reflects quantity supplied at varying prices.

• Price to Output Relationship

  • Price is linked with marginal cost; production requires price to cover variable costs (minimum AVC).

• Shutdown Decision

  • Firms continue production as long as TR ≥ TVC; loss per unit significantly impacts the decision to shut down when price < AVC.