chap. 13 ECON

Day 13: Firm Profits and Losses

Class Information

• Course: ECON 101: Principles of Microeconomics

• Instructor: Anderson Frailey

• Date: March 12, 2026

• Institution: University of Maryland, Baltimore County

• **Updates: **
    - Tests will be graded by end of the week.
    - Poll: Students asked whether to post grades now or after the break.

Agenda

• Topics Covered:
    - Firm Profits and Losses.
    - Open discussion.

Recap of Previous Material

• Topics Discussed Before:
    - How people make choices.
    - How firms try to maximize profits.
    - Perfect competition.
    - Elasticity.

Upcoming Topics

• Next Third of the Class Will Cover:
    - Government intervention: regulation, taxes, and subsidies.
    - Externalities, public goods, and inefficiency.
    - Imperfect competition: monopoly, oligopoly, and antitrust.
    - Labor markets: supply and demand, human capital, and minimum wages.
    - Inequality.

Firm Profits and Losses

Key Definitions

• Objective of Firms:
    - The primary goal is to maximize profits.

• Profit Calculation:
    - Profit = Total Revenue - Total Cost.
    - Total Revenue = Price × Quantity.
    - Total Cost = Fixed Costs + Variable Costs.

Cost Structures

• Average Total Cost (ATC):
    - $ext{ATC} = rac{TC}{Q} = rac{FC}{Q} + rac{VC}{Q}$

• Average Fixed Cost (AFC):
    - $ext{AFC} = rac{FC}{Q}$

• Average Variable Cost (AVC):
    - $ext{AVC} = rac{VC}{Q}$

• Note:
    - $Q = ext{Quantity}$

Marginal Concepts

• Marginal Cost (MC):
    - Defined as the increase in cost from increasing output by one unit.

• Marginal Revenue (MR):
    - Defined as the revenue gained from selling one more unit.

Profit Maximization Condition

• Condition for Profit Maximization:
    - Firms should produce where $MR = MC$.

Market Conditions in Perfect Competition

• Characteristics of Perfect Competition:
    - All firms are price takers, meaning they sell their good at the market price.
    - $MR = ext{Price}$ (since firms cannot influence market price).
    - Profit Maximizing Condition:
      - $ext{Price} = MR = MC$.
    - Demand is perfectly elastic; the firm demand curve also acts as the marginal revenue curve.

Profit and Loss Equations

• Profit Expressions:
    - Various expressions for calculating profit:
      - Profit = Total Revenue − Total Cost
      - Profit = (P × Q) − Total Cost
      - Profit = (P × Q) − (ATC × Q)
      - Profit = (P − ATC) × Q
    - Important Note: If Total Revenue < Total Costs, the firm incurs a loss.

Graphical Analysis

• Reading Costs from Graphs:
    - Costs can be identified graphically using demand and supply curves.

• Revenue Representation on Graph:
    - Area of a rectangle representing revenue: Area = Base × Height.
      - Base (B) = Quantity (Q);
      - Height (H) = Price (P);
      - Revenue = $P imes Q$.

• Total Costs on Graph:
    - $ext{Total Cost (TC)} = ext{Average Total Cost (ATC)} imes Q$.

Profit and Loss Indicators

• Profits:
    - When there are profits, MR > ATC.

• Losses:
    - Conversely, when there are losses, MR < ATC.

Long-Run Equilibrium in Perfect Competition

• Long-Run Zero Profit Condition:
    - In perfect competition, no firm achieves long-run profits due to free entry and exit in the market.
    - If firms make profits, new firms will enter the market, increase supply, and cause the equilibrium price to drop.
    - If firms incur losses, some will exit, reducing supply, which in turn will cause equilibrium prices to rise.

Transition Between Profits and Losses

• Shift from Profit to Loss:
    - The transition involves moving from a state with profits to one with losses due to supply adjustments.

• Change Dynamics:
    - When profits exist, firms enter:
      - Supply shifts right, decreasing price.
    - When losses exist, firms exit:
      - Supply shifts left, increasing price.

Price and Revenue Dynamics

• High Prices:
    - High prices lead to increased competition, which may decrease prices and lower overall revenue.

• Low Prices:
    - Extremely low prices can force firms to exit the market, eventually raising prices and boosting revenue again.

Shutdown Decisions

• Shutdown Point Determination:
    - The point where Average Variable Cost (AVC) and Marginal Cost (MC) curves intersect indicates the shutdown point.
    - In the short term, fixed costs do not influence the decision to shut down as they are considered sunk costs.
    - The shutdown decision is based on whether revenues can cover variable costs.

Criteria for Production Decisions

• Firms should produce if:
    - $ext{Revenue} ext{ } ext{≥ VC} ext{ or equivalently} ext{ } P imes Q ≥ VC$.
    - Alternatively, P imes Q > AVC ext{ or } Q imes P ≥ AVC.

• Firms should shut down if the above conditions do not hold.

Individual Firm Supply Curve

• Supply Curve Interpretation:
    - The Marginal Cost curve above the AVC represents the individual firm’s supply curve.
    - It indicates how much of the good firms are willing to produce at each price.
    - In perfect competition, firms operate where:
      - $ext{Price} = MR = MC ext{ } (≥ AVC)$.