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Profit maximization using the total revenue and total cost curves of a perfect competitor. To obtain the profit maximizing output quantity, we start by recognizing that profit is equal to total revenue minus total cost (). Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph.
The mathematical profit maximization conditions ("first order conditions") ensure the price elasticity of demand must be less than negative one, [2] [7] since no rational firm that attempts to maximize its profit would incur additional cost (a positive marginal cost) in order to reduce revenue (when MR < 0). [1]
The company is able to collect a price based on the average revenue (AR) curve. The difference between the company's average revenue and average cost, multiplied by the quantity sold (Qs), gives the total profit. A short-run monopolistic competition equilibrium graph has the same properties of a monopoly equilibrium graph.
Mathematically, the markup rule can be derived for a firm with price-setting power by maximizing the following expression for profit: = () where Q = quantity sold, P(Q) = inverse demand function, and thereby the price at which Q can be sold given the existing demand C(Q) = total cost of producing Q.
In a single-goods case, a positive economic profit happens when the firm's average cost is less than the price of the product or service at the profit-maximizing output. The economic profit is equal to the quantity of output multiplied by the difference between the average cost and the price.
Withholding production to drive prices higher produces additional profit, which is called monopoly profits. [ 2 ] According to classical and neoclassical economic thought, firms in a perfectly competitive market are price takers because no firm can charge a price that is different from the equilibrium price set within the entire industry's ...
Suppose a firm sets its output on this side, if it reduces the output, the cost will decrease from C and D which exceeds the decrease in revenue which is D. Therefore, decreasing output until the point of (marginal revenue=marginal cost) will lead to an increase in profit (Theory and Applications of Microeconomics, 2012). Profit Maximizing Graph
These functions describe each firm's optimal (profit-maximizing) quantity of output given the price firms face in the market, , the marginal cost, , and output quantity of rival firms. The functions can be thought of as describing a firm's "Best Response" to the other firm's level of output.