Lecture 7
Profit maximization of a firm in a competitive market
(monopoly -> firm chooses price and quantity)
In a competitive market, firms do not have market power. As the firm cannot choose the price, they
only have the option to vary the quantity produced.
Demand curve = firm’s feasible frontier (the slope = MRT) = flat and therefore MRT = 0
Isoprofit curves = firm’s indifference curves (the slope = MRS) = 0 as a firm cannot choose its price
and chooses the quantity they produce.
The profit of the firm is maximized if MR – MC = 0
and the slope of the tangent line to the profit curve = 0
With a price above the minimum level of AVC (average variable cost), q* is determined P (MR) = MC
->MC-curve is the supply-curve (as long as MC > AVC)
Normal profits: the profits a firm make are no higher than profits the firm could make somewhere
else using its assets.
Social welfare function: a function that ranks social states as less or more desirable or indifferent,
provides the government a guideline to achieve optimal distribution of income
Social efficiency: achieved at the point where the marginal benefits to society are equal to the
marginal costs to society.
Issues of equity: difficult to judge due to the subjective assessment of what is fair in distribution of
resources.
Look into technically feasible pareto improvement (slide 25 +/-)
If demand is less elastic, the fall in consumer surplus is larger than in producer surplus after setting up
taxes. The less elastic groups bears more of the tax burden.
Profit maximization of a firm in a competitive market
(monopoly -> firm chooses price and quantity)
In a competitive market, firms do not have market power. As the firm cannot choose the price, they
only have the option to vary the quantity produced.
Demand curve = firm’s feasible frontier (the slope = MRT) = flat and therefore MRT = 0
Isoprofit curves = firm’s indifference curves (the slope = MRS) = 0 as a firm cannot choose its price
and chooses the quantity they produce.
The profit of the firm is maximized if MR – MC = 0
and the slope of the tangent line to the profit curve = 0
With a price above the minimum level of AVC (average variable cost), q* is determined P (MR) = MC
->MC-curve is the supply-curve (as long as MC > AVC)
Normal profits: the profits a firm make are no higher than profits the firm could make somewhere
else using its assets.
Social welfare function: a function that ranks social states as less or more desirable or indifferent,
provides the government a guideline to achieve optimal distribution of income
Social efficiency: achieved at the point where the marginal benefits to society are equal to the
marginal costs to society.
Issues of equity: difficult to judge due to the subjective assessment of what is fair in distribution of
resources.
Look into technically feasible pareto improvement (slide 25 +/-)
If demand is less elastic, the fall in consumer surplus is larger than in producer surplus after setting up
taxes. The less elastic groups bears more of the tax burden.
