Hello tom123!
The profit maximizing ouput does not only depend on the marginal cost
curve, but also depends on the marginal revenue curve, which, in turn,
is different if the firm is a monopolist or is perfectly competitive.
Let us first turn our attention to the marginal cost curve. The
marginal cost curve shows the cost of producing an extra unit of the
good. For example:
Quantity Marginal Cost
1 $10
2 $12
3 $15
4 $20
mens that first unit costs $10, the second unit costs $12, etc. Thus,
in order to produce two units, the firm would incur a total cost of
$10+$12=$22. This example is a case of *increasing* marginal costs:
each extra unit costs more than the previous ones. There are also
cases of decreasing marginal costs (each extra unit costs less then
the previous one) and constant marginal costs (each unit costs the
same).
Let us assume for now that the firm faces an increasing marginal cost
curve (this is the typical case, because it corresponds to decreasing
productivity of labour and capital), just as in the example. Now, we
distinguish two main cases:
1) Perfect Competition
If a firm is in a perfectly competitive market, then it's too small to
set the price by itself: it takes the price as given. If it wanted to
raise the price above the market price, then nobody would want to buy
from this firm, as there are many others that sell the same product.
Also, as each firm is very small relative to the market, the firm can
sell as many goods as it wants at the market price. So, let's consider
the bananas market. Say each banana sells for $16. Now a firm enters
the bananas market as a producer (recall it has to sell each one for
$16), and faces the marginal cost schedule I mentioned in the above
example. How many bananas should it produce?
This question can be answered by doing a 'marginal analysis'. Should
the firm produce the first banana? Yes, because it costs $10 and sells
for $16. Should it produce the second one? Yes: it costs $12, and
sells for $16. The same goes for the third one. The cost of the fourth
is higher than the price it sells for, so the firm oesn't produce it.
Thus, the firm maximizes profits by producing 3 bananas.
Let's generalize the method. I talked earlier about the marginal
revenue curve. This is, as the name implies, the revenue for selling
an extra unit of the good. The marginal revenue curve, in a perfectly
competitive market, is CONSTANT: recall that in the above example each
banana sells at $16, the market price. The revenue from the first
banana is $16, and so is the revenue from the second one, etc. In
conclusion:
"The perfectly competitive firm should continue to increase its output
if and only if the marginal revenue (or price) received from selling
that output exceeds the marginal cost of producing the output. The
firm will then be maximizing profit."
http://highered.mcgraw-hill.com/sites/0070889740/student_view0/chapter6/cyberlecture.html#practice1
Or, if you have a continuous marginal cost curve, you would say that
the profit is maximal when the output is such that the marginal
revenue equals the marginal cost.
Graphically, if you have output in the x-axis, and marginal revenue
and cost in the y-axis, then the profit-maximizing output is the one
where the marginal cost curve (an increasing function) intersects the
marginal revenue curve (which is a flat line at the market price).
2) Monopoly
The last two paragraphs (that summarize how profit is maximized) are
still valid for the monopoly case. The only difference here is that
the marginal revenue is not constant. If the firm is a monopolist, it
has the power to choose whatever price it wants (as opposed to the
previous case where the firm takes the price as given). Now recall the
Law of Demand (quoting livioflores-ga): "the quantity of a good
demanded will rise with every fall in its price and the quantity of a
good demanded will fall with every rise in its price". Let's analyze
what this implies for the marginal revenue curve. The first unit can
be sold at a certain price. Now, the second unit, because of the law
of demand, cannot be sold for the same price, as more quantity implies
a smaller price (law of demand). The marginal revenue from the secound
unit is thus lower than the marginal revenue of the first one. This
implies a *decreasing* marginal revenue curve. But again, the rule for
maximizing profit is the same: choose output such that marginal
revenue equals marginal cost. Since one curve is increasing and the
other one is decreasing, this intersection will exist.
As a final remark, it's noteworthy that maximizing profits doesn't
mean that the firm makes any actual profits, because the marginal
analysis ignores the fixed costs. For example, returning to case (1).
The profits from the 3 bananas are (16-10) + (16-12) + (16-15) = $9.
However, the firm might have a fixed cost of $100. In this case
profits = 9-100 = -$91. The firm would be better off if it closes,
earning $0 profits rather than $-91.
Sources
The Profit Maximizing Output
http://ingrimayne.saintjoe.edu/econ/MakeProfit/OptimalOutput.html
Principles of Microeconomics, 1st Canadian edition
http://highered.mcgraw-hill.com/sites/0070889740/student_view0/chapter1/cyberlecture.html
Principles of Microeconomics: Unit 9
http://spot.colorado.edu/~kaplan/econ2010/section9/section9-main.html
(go to "Profit Maximization and the Perfectly Competetive Firm)
Principles of Microeconomics: Unit 8
http://spot.colorado.edu/~kaplan/econ2010/section8/section8-main.html
(for information on what the marginal cost is)
Search terms
introduction microeconomics marginal cost maximize
I hope the answer was clear enough. Good luck with your future
research!
elmarto |
