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Profit Maximization in the Short-run: TR/TC Approach
- Firm = price taker → firms can only adjust output to maximize profit
- Short-run = fixed plant → firms can only adjust amount of variable resource such as labor and materials.
- 2 ways to determine maximum profit & minimum loss output level
- Total-revenue-total-cost approach
- Marginal-revenue-marginal-cost approach
- Both apply to pure competition, pure monopoly, monopolistic competition, oligopoly
- Should we produce this product? Profit → Yes; Loss→ No
- In what amount?
- Output level where economic profit is maximized
- TR– TC = (P x Q) - (FC + VC) = economic profits
- Break-even point = when normal profit is satisfied
- Intersection of TC + TR (TR covers all TC)
- No economic profit – only normal
- There are 2 break-even points on graph – any point in between is economic profits
- Profit is maximized on a graph where the vertical distance between TR and TC is the greatest
- At break even point 1: the industry should PRODUCE MORE!
- At profit max point: the vertical distance between TR and TC is at its greatest, meaning the firm is earning maximum economic profits; therefore, industry should keep producing at this level of output, because more profits can still be made!
- At break even point 2: STOP PRODUCING! or REDUCE the quantity producing! TR and TC are equal, meaning the firm is now only earning a normal profit.
- The exact point in which profit is maximized is difficult to pinpoint from inspection, which is why the MR=MC method is stronger.
- The reason why a profit-max point can be found is due to the law of diminishing returns.
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