|
Marginal analysis of profit maximization As long as the price is unaffected by the number of units the firm sells, the marginal revenue of selling an additional unit will be its price, the change in total revenue due to each extra unit sold is expressed as follows ∆TR = P * ∆Q. Therefore MR = P for a competitive firm. When choosing profit maximizing output, managers compare MC and MR for each unit sold. => MR> MC, selling an additional item increases profit. => MR< MC, selling an additional item decreases profit. The change in profits from selling an additional item is the difference between the MR from that item and its MC. Marginal profit - the additional profit that results from the sale of an additional unit of output => Marginal profit = MR - MC. Because price is equal to MR for a competitive firm, maximum profits occurs when output has been adjusted to the point at which MC rises to the equal market price. The marginal condition for profit maximization by a single-product competitive firm is therefore: P = MC. The equilibrium of profit maximizing competitive firm is the output for which price = marginal cost. => Any output below this level implies that the firm can increase profits by producing more. => Any output above this level implies that the firm can increase profits by producing less output. Choosing output in the short run. In the short run a firm operates with the fixed amount of capital ($50) and must confine to the levels of its variable inputs (Labor and raw materials) to maximize profit.
Note, that for low levels of output the firms profit is negative. The revenue is insufficient to cover fixed and variable costs as output increases profit becomes positive and increases until output reaches 8 units. Beyond 8 units of production profit falls reflecting the rapid increase in the total cost of production. Profit is therefore maximized at q* = 8 units where the MR is close to MC. |