Lesson 4 REVENUE PROFIT MAXIMISATION LOSS MINIMISATION REVENUE
- Slides: 10
Lesson 4 REVENUE, PROFIT MAXIMISATION & LOSS MINIMISATION
REVENUE, PROFIT MAXIMISATION & LOSS MINIMISATION Learning Objectives • Calculate TR, AR and MR given P and point out their relationships assuming P remains or falls when Q increases. • Determine the optimum output level and explain why it should be at the point where MR = MC regardless of the market structure. • Explain how firms earn profits or incur losses. • Prove that even a loss making firm would prefer to continue if its AR > AVC. • Distinguish firms’ equilibrium under both a perfectly competitive market and a monopolistic market, highlighting their similarities as well as their differences.
4. 1 TOTAL REVENUE (TR) = AVERAGE REVENUE (AR) X QUANTITY (Q) • THEREFORE : AR = TR/Q • Relationship of P, AR and MR under Perfect Competition
4. 2 Profit Maximizing Output in a Perfectly Competitive Market The profit maximizing output (or loss minimizing output) is always at the point where MC = MR.
IS THE FIRM PROFITABLE PRODUCING AT THIS OPTIMUM OUTPUT? • To find out we need to know the firm’s ATC and AR. If at this optimum output (where MR = MC) the firm’s AR>ATC, the answer is yes. • If at this optimum output (where MR = MC) the firm’s AR<ATC, the answer is no.
4. 3 THE LOSS MAKING FIRM • What will a loss making firm do? The answer is that it may shut down immediately or continue in the short run. • If the firm’s P or AR > AVC, it will be better to continue it is better for the firm to continue. This is because the loss is greater if the firm shuts down. • But if the firm’s P or AR < AVC, it is better for the firm to shut down. This is because the loss is greater if the firm continues.
4. 4 RELATIONSHIP OF P, AR AND MR UNDER MONOPOLISTIC MARKET
4. 5 PROFIT MAXIMIZATION UNDER MONOPOLISTIC MARKET • Apart from this difference, the analysis of optimum output and profit or loss is exactly as was discussed under the perfectly competitive model. • In other words, optimum output is still at the point where MR = MC. If at this output AR > ATC, the firm is profitable; if not, it is loss making. • If at this output, AR < ATC, the firm is making losses. If at the same time the firm’s AR > AVC, it will continue. But if AR < AVC it will be shut down condition like the perfectly competitive model.
PROFIT MAXIMIZATION UNDER MONOPOLISTIC MARKET
Class discussion
