Chapter 14
Chapter 14
TR
• Average revenue (AR) AR =
Q
=P
Q TR TC Profit MR MC
Profit =
At any Q with MR – MC
MR > MC,
0 $0 $5 –$5
increasing Q $10 $4 $6
raises profit. 1 10 9 1
10 6 4
2 20 15 5
At any Q with 10 8 2
MR < MC, 3 30 23 7
10 10 0
reducing Q 4 40 33 7
raises profit. 10 12 –2
5 50 45 5
MC and the Firm’s Supply Decision
Rule: MR = MC at the profit-maximizing Q.
At Q1, MC = MR.
Changing Q
would lower profit. Q
Qa Q1 Qb
MC and the Firm’s Supply Decision
If price rises to P2,
then the profit- Costs
maximizing quantity
MC
rises to Q2.
P2 MR2
The MC curve
determines the
firm’s Q at any price. P1 MR
Hence,
The firm’s SR
supply curve is Costs
the portion of MC
its MC curve
aboveIf AVC.
P > AVC, then
firm produces Q ATC
where P = MC.
AVC
The firm’s
Costs
LR supply curve is
the portion of MC
its MC curve
above LRATC.
LRATC
Q
Market Supply: Assumptions
1) All existing firms and potential entrants have
identical costs.
2) Each firm’s costs do not change as other firms
enter or exit the market.
3) The number of firms in the market is
– fixed in the short run
(due to fixed costs)
– variable in the long run
(due to free entry and exit)
The SR Market Supply Curve
• As long as P ≥ AVC, each firm will produce its
profit-maximizing quantity, where MR = MC.
• Recall from Chapter 4:
At each price, the market quantity supplied is
the sum of quantities supplied by all firms.
The SR Market Supply Curve
Example: 1000 identical firms
At each P, market Qs = 1000 x (one firm’s Qs)
P2 P2
AVC
P1 P1
Q Q
10 20 30 (firm) (market)
LRATC
P=
long-run
min. supply
ATC
Q Q
(firm) (market)
SR & LR Effects of an Increase in Demand
A firm begins in …but then an increase in
long-run to …driving
…leadingeq’m… SR profits to zero
Over time, profits
demand induce
raisesentry,
P,…
and
profits for the restoring
firm. long-run
shifting eq’m.
S to the right, reducing P…
S2
Profit ATC B
P2 P2
A C long-run
P1 P1 supply
D2
D1
Q Q
(firm) Q1 Q2 Q3 (market)
Why the LR Supply Curve Might Slope Upward