3. Economic profit in trtc-model and in mrmc-model
A
ccording
to graphical interpretation maximum Economic Profit occurs at output
level Q*,
the greatest vertical distance between TR and TC. On the Figure 2 the
quantity Q*
can
provide such level of profit.
a and b points are break-even points – as under corresponding quantity there is neither profit nor losses (TR=TC).
Then, the areas before a- break-even point and after b- break-even point shows losses of producer.
The angle of slope of TR line and the angle of slope TC curve are equal under Q*. That means that coefficients ΔTC/ΔQ=ΔTR/ΔQ. But as it is the same that MR=MC, the rule of profit maximization for perfect competitor is: MC=MR=P.
Another way to illustrate it is to use average and marginal costs graph.
On this graph economic profit is shown as an EP area.
T
he
point of MR and MC intersection shows the optimal level of output Q*
under
definite price P.
And as the firm is “price taker” in this case it will regulate the output according to profit maximization rule all the time. But the result can vary because of the costs level.
4. The Competitive Firm and Industry Demand
The individual firm's demand curve is different from that of the industry, and is more elastic. This is because substitutes increase elasticity, and the customer of the firm has many good substitutes for that firm's output – namely, the output of other firms in the industry. As we mentioned above, the demand curve for a P-Competitive firm is infinitely elastic:
Figure 4
In the figure, the lower case q, s and d refer to output, supply and demand from the point of view of the individual firm, respectively, and the capital S, D, and Q are for the industry as a whole.
4.1. Economic strategies of the firm at p- Competition
H
ow
much output should firm sell, at the given price to maximize profits.
The
answer is: increase output until P=MR=MC
Now we will use this rule as a basic rule to consider the firm economic strategies.
In the picture just shown, the firm is making an "economic profit." All costs, explicit and implicit, are included in the firm's Average Cost curve.
Profitableness and losses conditions for perfect competitor according to mrmc-model:
a
firm
has profit under:
break-even point
losses
minimization condition through production continuance:
losses
minimization condition through temporary dissolution of the firm:
–
dissolution
bundle.
Figure 6.
Firm’s reaction on price change
In other words if the cost of and additional unit (MC) is less than the revenue obtained from that same additional unit (MR), producing the additional units will add to profits (or reduce losses). If the cost of additional units of output (MC) cost more than they add to revenue (MR), the firm should not produce the additional units. The rules for profit maximization are simple:
• MR >MC – produce it!
• MR < MC – don’t produce it!
• When MR = MC – you are earning maximum profits!
MR=MC is the main principle of supply for the individual firm. Supply is the relation between the price and the quantity that people want to sell. For an individual firm, that is: the relation between the price and the quantity the firm wants to sell. So we ask: at a given price, how much will a (profit- maximizing) firm want to sell? The answer: enough so that the price is equal to marginal cost. In other words, the marginal cost curve is the supply curve for the individual firm.