Part 2: Profit-Maximizing Objective
Accounting vs Economic Profit
AP = TR - TC, TC is firm's explicit costs
EP = TR - TC, TC is sum of explicit and implicit costs
Types of Economic Profit
Normal
Min. profit to induce firm to continue operating, insufficient to attract new firms to enter industry. TR=TC
Supernormal
Above normal profit, earnings in excess of what could be earned in next best alternative, attracts new firms. TR>TC
Subnormal
Below normal profit, earn less than what could be earned in next best alternative, forces least efficient firms to leave industry. TR<TC
Profit Maximization based on Marginalist Principle
Firm assumed to be in equilibrium when it maximizes total economic profits (MC=MR where MC is rising)
Price-taker Firm
- MC=MR at A and B but profits not maximised at A as at output levels higher than Qa, additional cost in increasing an additional unit of output (MC) is less than the additional revenue (MR) such that each additional unit produced will bring about higher profits for the firm. Incentive to ⬆production until Qb.
- Above Qb, producing additional unit of output adds more to total cost than to total revenue (MC>MR) hence expansion beyond Qb depletes profits.
- Equilibrium Pe,Qe.
Normal Profit
Price-setter Firm
Same explanation as for price-taker
Pe determined by AR (D curve)
Normal Profit
Supernormal Profit
Subnormal Profit
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Supernormal Profit
Subnormal Profit
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