1 Microeconomics
Chapter 8: Profit maximization & competitive supply.
1.1 Problem statement & learning goals
How do firms in competitive markets decide how much to produce & at which price?
After this chapter you can;
• determine the short run supply curve of a firm & the industry
• decide when a firm should shut down
• choose profit maximizing price & output in both the short & long run
• calculate a firm’s profit & producer surplus
1.2 Recap: Cost of production (chapter 7) Diff types of costs, one way of representing this is
via curves.
• Fixed costs ⇒ vaste kosten, they do not
vary with output, remain constant
(verzekeringen/ huur)
• Variable costs ⇒ The TC is just a vertical
sum of FC & the VC.
Exactly the same for the avg cost.
Average fixed cost, decline, FC is constant so we
Tangent ➔ raaklijn
divide the same number by an increasing
number of outputs.
Margin costs ⇒ very important, is the slope of
tangent, is the straight line, that touches the
curve in one point.
Verband AVC & MC
MC: helling v/d raaklijn aan VC (deze is dezelfde
als de helling v/d raaklijn aan TC)
AVC: helling v/d rechte van oorsprong naar een
punt op VC
ATC: helling v/d rechte van oorsprong tot een
punt op TC
MC = AVC wanneer AVC zijn minimum bereikt
(hier: bij q = 7)
MC = ATC wanneer ATC zijn minimum bereikt
MC is the additional cost incurred by producing one more unit of
a good or service. In het snijpunt met de MC & AVC daalt AVC als
MC lager is dan de AVC, AVC will decline &
andersom
Why is the short run marginal cost curve U-shaped?
Law of diminishing marginal returns
• at low levels of output, the productivity of the inputs increases thanks to specialization
➔MP increases & MC decreases
,2 Microeconomics
• at higher levels of output, the law of diminishing Reason why the shortcut MC is U shaped, when we think about
marginal returns applies the economy & firms we assume that they are U shaped,
➔ MP decreases & MC increases everything else is due to the shape of the margin cost. Why
assume U shape ⇒ is the law of diminishing margin returns,
Law of Diminishing Marginal Returns: "As you add more means when you are at low level of output, the productivity of
input increased due to specialization. Example ⇒ bring new
of 1 input (like workers or machines) while keeping other
workers, specialization, the output will increase, the MC will be
inputs constant, the additional output or benefit you get decreasing, but if we have too many employees they will start to
from each additional unit of the input will eventually stand in each other's way. & that’s why it’s U shaped.
decrease. In other words, there's a point where adding
more of something doesn't increase output as much as before."
Long run vs short run costs:
• Short run:
o shape of AC & MC in the short run? ➔U shape
o explanation? ➔ Law of diminishing marginal returns.
• Long run:
Difference between the 2, that in the short run we face fixed
factors of production, we can’t change capital, machine is fixed
etc. We can change labour tho, while in the long run nothing is
fixed, we can buy or build a machine. Consequence, is the law
of diminishing marginal returns only true in short term, in the
long term we don’t have this problem.
Reason we have a u shaped avg cost, we assume we have first, increasing, constant & then
downgrading “returns on scales???”
LAC & LMC are U shaped, MC, intersect each other in the minimum, if the LMC is smaller than LAC,
the addition of cost are smaller than the avg of the units before & therefore the avg will increase.
1.3 Profit maximization
Profit = Revenue – Costs
Π = R(q) – C(q) →C(q)= Cost-minimizing combination of inputs
= profit maximization
➔ Both revenue & costs are depending on the quantity that we sell. When we talk about the cost ➔
you choose the cost minimizing combination. We always talk about this, the inefficient solutions are
not part of this.
,3 Microeconomics
Why do the revenues have this shape?
The more you increase output, the more you want to sell
then at some point you need to lower the price. & then
revenues are actually a conclave. We are interested in the
profit, so we want to know the difference between the pink
& purple line ➔ in point 0 the profit is 0, between 0 & q0 the
profit is negative. q* is a very special point, you get the
impression that the difference is maximized & this is indeed
true –> you can see this when you draw the profit ➔ the
yellow line is at its maximum. We can see now that profit is
maximized when MR = MC
q* ⇒ difference between these 2 curves is maximized marginal revenue = the slope of a tangent in point Amarginal
cost = the slope of a tangent in point
Yellow curve ⇒ is the profit the highest point where
the biggest difference is between the C & the R. Band these lines are parallel which means that the slope is
the same!! in competitive markets the revenues are constant
R(q) begint niet bij 0 want je hebt al FC so it will be a straight line
MR ➔ additional revenue that we get from selling 1
more unit
MC ➔ additional cost from producing 1 extra unit.
Perfect competition ➔ Assumptions
1.market atomism ➔ price takers: In a perfectly competitive market, individual firms
are so small relative to the entire market that they cannot influence the market price
by their own actions. They accept the market price as given & can sell any quantity at that price.
2.homogeneous products / substitutes (commodities): Products sold by firms in a perfectly
competitive market are identical or homogeneous. Consumers view the products as perfect
substitutes for each other, & there are no perceived differences in quality, branding, or other
attributes.
3.free entry & exit: Firms can freely enter or exit the market without facing any significant barriers.
4.perfect information: Participants in the market, including buyers & sellers, have complete &
accurate info about the prices, costs, & quality of products. This assumption ensures that all market
participants can make well-informed decisions.
Profit maximization
P = MR = AR (Average revenue)
so that MR = MC → P = MC 1. Demand (D):
represents the quantity of a good or service
that consumers are willing & able to buy at
various prices during a given period.
2. Supply (S):
represents the quantity of a good or service
that producers are willing & able to offer for
sale at various prices during a given period.
, 4 Microeconomics
Individuele markt: Kleine letter, de prijs is fixed
1.3 Choosing output in the short run This figure shows the short run decision
- When this firm produces 8 units of output the
profit is maximized (MC=AR=MR=P). P dat mensen
bereidt zijn om te betalen.
-When we produce less than 8, than the marginal
costs would be smaller than the Price, so we have
less revenue
MC > MR: Imagine you're making & selling a product. If the cost of making 1 more unit (MC) is higher
than the money you earn from selling that unit (MR), it's like spending more to produce than you get
back in revenue. So, it's not a good idea to produce more in this situation.
MR > MC: On the other hand, if the money you earn from selling one more unit (MR) is higher than
the cost of making that unit (MC), it means you're making more profit by producing & selling more. In
this case, it's a good idea to make & sell more units to increase your overall profit.
In summary, a business aims to produce where MR equals MC to maximize profit. If MR is higher,
produce more; if MC is higher, produce less. It's about finding the right balance to make the most
profit.
in q* we are producing 8 units & we would have
point B as average total costs this means that for
8 units, we have 30 $ as costs on average but we
can sell each of these units for a market price of
40 $ ➔the rectangle is the total profit = the
difference between the AVC that we have per
unit & the difference to the market price which is
what we get as a profit for each unit
In this situation we have higher fixed costs so
when we compare with the previous graphic, the
ATC is close to the AVC but here the 2 cost lines
are much further away from each other. When
we look at total profit, we actually have higher
costs for each unit than the price ➔ foreach unit
that you sell you get P but on average you have a
total cost that is higher so this means that the
rectangle is a situation where we have a loss.
Chapter 8: Profit maximization & competitive supply.
1.1 Problem statement & learning goals
How do firms in competitive markets decide how much to produce & at which price?
After this chapter you can;
• determine the short run supply curve of a firm & the industry
• decide when a firm should shut down
• choose profit maximizing price & output in both the short & long run
• calculate a firm’s profit & producer surplus
1.2 Recap: Cost of production (chapter 7) Diff types of costs, one way of representing this is
via curves.
• Fixed costs ⇒ vaste kosten, they do not
vary with output, remain constant
(verzekeringen/ huur)
• Variable costs ⇒ The TC is just a vertical
sum of FC & the VC.
Exactly the same for the avg cost.
Average fixed cost, decline, FC is constant so we
Tangent ➔ raaklijn
divide the same number by an increasing
number of outputs.
Margin costs ⇒ very important, is the slope of
tangent, is the straight line, that touches the
curve in one point.
Verband AVC & MC
MC: helling v/d raaklijn aan VC (deze is dezelfde
als de helling v/d raaklijn aan TC)
AVC: helling v/d rechte van oorsprong naar een
punt op VC
ATC: helling v/d rechte van oorsprong tot een
punt op TC
MC = AVC wanneer AVC zijn minimum bereikt
(hier: bij q = 7)
MC = ATC wanneer ATC zijn minimum bereikt
MC is the additional cost incurred by producing one more unit of
a good or service. In het snijpunt met de MC & AVC daalt AVC als
MC lager is dan de AVC, AVC will decline &
andersom
Why is the short run marginal cost curve U-shaped?
Law of diminishing marginal returns
• at low levels of output, the productivity of the inputs increases thanks to specialization
➔MP increases & MC decreases
,2 Microeconomics
• at higher levels of output, the law of diminishing Reason why the shortcut MC is U shaped, when we think about
marginal returns applies the economy & firms we assume that they are U shaped,
➔ MP decreases & MC increases everything else is due to the shape of the margin cost. Why
assume U shape ⇒ is the law of diminishing margin returns,
Law of Diminishing Marginal Returns: "As you add more means when you are at low level of output, the productivity of
input increased due to specialization. Example ⇒ bring new
of 1 input (like workers or machines) while keeping other
workers, specialization, the output will increase, the MC will be
inputs constant, the additional output or benefit you get decreasing, but if we have too many employees they will start to
from each additional unit of the input will eventually stand in each other's way. & that’s why it’s U shaped.
decrease. In other words, there's a point where adding
more of something doesn't increase output as much as before."
Long run vs short run costs:
• Short run:
o shape of AC & MC in the short run? ➔U shape
o explanation? ➔ Law of diminishing marginal returns.
• Long run:
Difference between the 2, that in the short run we face fixed
factors of production, we can’t change capital, machine is fixed
etc. We can change labour tho, while in the long run nothing is
fixed, we can buy or build a machine. Consequence, is the law
of diminishing marginal returns only true in short term, in the
long term we don’t have this problem.
Reason we have a u shaped avg cost, we assume we have first, increasing, constant & then
downgrading “returns on scales???”
LAC & LMC are U shaped, MC, intersect each other in the minimum, if the LMC is smaller than LAC,
the addition of cost are smaller than the avg of the units before & therefore the avg will increase.
1.3 Profit maximization
Profit = Revenue – Costs
Π = R(q) – C(q) →C(q)= Cost-minimizing combination of inputs
= profit maximization
➔ Both revenue & costs are depending on the quantity that we sell. When we talk about the cost ➔
you choose the cost minimizing combination. We always talk about this, the inefficient solutions are
not part of this.
,3 Microeconomics
Why do the revenues have this shape?
The more you increase output, the more you want to sell
then at some point you need to lower the price. & then
revenues are actually a conclave. We are interested in the
profit, so we want to know the difference between the pink
& purple line ➔ in point 0 the profit is 0, between 0 & q0 the
profit is negative. q* is a very special point, you get the
impression that the difference is maximized & this is indeed
true –> you can see this when you draw the profit ➔ the
yellow line is at its maximum. We can see now that profit is
maximized when MR = MC
q* ⇒ difference between these 2 curves is maximized marginal revenue = the slope of a tangent in point Amarginal
cost = the slope of a tangent in point
Yellow curve ⇒ is the profit the highest point where
the biggest difference is between the C & the R. Band these lines are parallel which means that the slope is
the same!! in competitive markets the revenues are constant
R(q) begint niet bij 0 want je hebt al FC so it will be a straight line
MR ➔ additional revenue that we get from selling 1
more unit
MC ➔ additional cost from producing 1 extra unit.
Perfect competition ➔ Assumptions
1.market atomism ➔ price takers: In a perfectly competitive market, individual firms
are so small relative to the entire market that they cannot influence the market price
by their own actions. They accept the market price as given & can sell any quantity at that price.
2.homogeneous products / substitutes (commodities): Products sold by firms in a perfectly
competitive market are identical or homogeneous. Consumers view the products as perfect
substitutes for each other, & there are no perceived differences in quality, branding, or other
attributes.
3.free entry & exit: Firms can freely enter or exit the market without facing any significant barriers.
4.perfect information: Participants in the market, including buyers & sellers, have complete &
accurate info about the prices, costs, & quality of products. This assumption ensures that all market
participants can make well-informed decisions.
Profit maximization
P = MR = AR (Average revenue)
so that MR = MC → P = MC 1. Demand (D):
represents the quantity of a good or service
that consumers are willing & able to buy at
various prices during a given period.
2. Supply (S):
represents the quantity of a good or service
that producers are willing & able to offer for
sale at various prices during a given period.
, 4 Microeconomics
Individuele markt: Kleine letter, de prijs is fixed
1.3 Choosing output in the short run This figure shows the short run decision
- When this firm produces 8 units of output the
profit is maximized (MC=AR=MR=P). P dat mensen
bereidt zijn om te betalen.
-When we produce less than 8, than the marginal
costs would be smaller than the Price, so we have
less revenue
MC > MR: Imagine you're making & selling a product. If the cost of making 1 more unit (MC) is higher
than the money you earn from selling that unit (MR), it's like spending more to produce than you get
back in revenue. So, it's not a good idea to produce more in this situation.
MR > MC: On the other hand, if the money you earn from selling one more unit (MR) is higher than
the cost of making that unit (MC), it means you're making more profit by producing & selling more. In
this case, it's a good idea to make & sell more units to increase your overall profit.
In summary, a business aims to produce where MR equals MC to maximize profit. If MR is higher,
produce more; if MC is higher, produce less. It's about finding the right balance to make the most
profit.
in q* we are producing 8 units & we would have
point B as average total costs this means that for
8 units, we have 30 $ as costs on average but we
can sell each of these units for a market price of
40 $ ➔the rectangle is the total profit = the
difference between the AVC that we have per
unit & the difference to the market price which is
what we get as a profit for each unit
In this situation we have higher fixed costs so
when we compare with the previous graphic, the
ATC is close to the AVC but here the 2 cost lines
are much further away from each other. When
we look at total profit, we actually have higher
costs for each unit than the price ➔ foreach unit
that you sell you get P but on average you have a
total cost that is higher so this means that the
rectangle is a situation where we have a loss.
