The rule of profit maximizing. Decision of termination or continuation of a competitive firms production in the short run. The supply curve.

Usually firms try to increase their profit. If firm produces good in given price of market then its price does not depend on quantity of produced goods. So in this case demand curve of competitive firm will be horizontal line.

Total revenue of firm is product of price to quantity and the formula is TR=pQ. Economic profit is p = TR – TC. If firm has zero economic profit, then it has normal accounting profit. This revenue is minimal profit that compensates the firm’s opportunity cost. Average revenue is profit from selling of each unit: AR = . Marginal revenue is change of revenue due to change in quantity: MR = .

Necessary condition to maximize profit is equality to zero of derivative of p: p' = (TR)' – (TC)' = 0. Since (TR)' = (pR)' = p and (TC)' = MC then MC = p. It means to have maximum profit marginal cost of firm should be equal to price of good.

1) p> min ATC

TR = p*Q_pm = S_OPAQpm

TC = AC* Q_pm = S_OCPQpm

p = TR – TC = S_CPAB > 0

2) min AVC< p< min AC

AC =

TR = S_PBAQpm

TC = S_OCBQpm

p = -S_PCBA (economic loss)

FC = S_FSAH

In case of stopping production the loss would be more and profit covers fixed costs, but it doesn’t cover average costs and sell of each product helps to cover FC. So it’s better to continue production.

3) p < min AVC

TR = S_OPAQ

TC = S_OCBQ

p = -S_PCBA < 0

FC = S_FCBH

VC = S_OFHQ

In this case p doesn’t cover even FC so firm should stop production.

Supply curve of competitive company is part of marginal cost curve which is above AVC, it is increasing part of it.

Profit Maximization Rule

In economics, profit maximization is the short run or long run process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem. The total revenue–total cost perspective relies on the fact that profit equals revenue minus cost and focuses on maximizing this difference, and themarginal revenue–marginal cost perspective is based on the fact that total profit reaches its maximum point where marginal revenue equals marginal cost.

At A, Marginal Cost < Marginal Revenue, then for each extra unit produced, revenue will be greater than the cost, so you will produce more.

At B, Marginal Cost > Marginal Revenue, then for each extra unit produced, the cost will be greater than revenue, so you will produce less. Thus, optimal quantity produced should be at MC = MR

A graph showing the hypothetical supply of a product or service that would be available at different price points. The supply curve usually slopes upward, since higher prices give producers an incentive to supply more in the hope of making greater revenue. In the short run the price-supply tradeoff is greater than in the long run. In the short run, an increase in price will usually cause an increase in supply, but the leading producers can only manage a limited increase. However, in the longer term, new producers enter the market attracted by higher prices, and the supply at each price increases more significantly. In theory, in the most extreme cases, supply can be totally unreactive to price (special cases of very uncompetitive markets), or supply can be infinite at a particular price (e.g. a highly competitive market).