Profits Flashcards
What is the short-run supply curve?
Marginal Cost Curve above its intersection with the Average Variable Cost Curve
Order of curves: AVC, ATC, MC
MC > ATC > AVC
Quantity Supplied is
the quantity of a good which firms would like to sell today, at today’s price
Supply (or the supply function) is
the quantity of a good
which firms would like to sell in a given period, showing how this depends on its price, input prices, and so on
The Supply Curve shows the relationship between
price and the quantity supplied, holding other things constant
What happens to the supply curve if there’s technical progress?
The whole curve shifts (typically right) - sell more of a given price
What happens to the supply curve if there’s more firms? and why?
Shift left:
more firms in an industry will normally be able to produce more (in total), and their profit margins will normally fall, so they sell at a lower price
What are two causes of shifts to the supply curve by changes in other goods?
Substitutes in production: you need a higher price if you can make more money from selling an alternative product (business or economy class tickets)
Complements in production: you can accept a lower price if revenues from a co-product go up (passengers and freight)
What is own-price elasticity?
A relative measure of how the quantity supplied of a good responds to changes in its price
Percentage change in quantity supplied over percentage change in price
Is own-price elasticity positive or negative?
Always positive if the law of supply holds
What affects the supply elasticity?
- Firms operating at full capacity?
- Barriers to entry?
- Timescale?
- Supply more elastic in long term than short term
How does elasticity/inelasticity effect the supply curve?
Y +ve for more elastic
Why do firms engage in production?
For Profit with Profit Maximisation as key objective
The firm’s total profits are
the difference between the total revenue it earns from the sale of units of output and the total cost incurred in their production
Total revenue - total costs
Total Revenue =
Price * Quantity
Average Revenue =
Total revenue divided by number of units sold
also market price
Marginal revenue
Change in total revenue arising from an additional unit sold
Profit maximisation implies
Marginal revenue = marginal cost
How do we calculate marginal revenue?
Derivative of (TR)/(Q)
How do we calculate marginal cost?
Derivative of (TC)/(Q)
What’s the second order condition for profit maximisation?
Second derivative of first TC(TR)/Q condition value - has to be less than 0
This ensures MC is rising
The behaviour of the firm’s revenues depends on
whether the firm has to cut price to increase sales due to market position
What are two general situations for firm behaviour?
The firm is a price taker
- a single firm has no influence on the market price
The firm is a price maker (a price setter)
- the firm is big enough to influence the market price
The market demand curve describes
the total revenue that firms
together can earn (within that market) at different market prices
Describe the demand curve if the firm is a price taker
- Demand curve and MR curve coincide horizontally at market price
- Firm earns Pm on every unit sold
- Extra revenue from the sale of an extra unit is Pm
How do price takers maximise profit?
expanding production up to the point at which MR=MC
Since MR = P, profits are maximised at P=MC
What is MR for a price taker?
Market Price
How does quantity sold by price taking firm effect market price?
Doesn’t influence
Total profits for profit maximisation of a price taker are
equal to profit per unit times the number of units sold, which is the area (P-SATC)q
What type of profits are a firm making before MC and SATC intersect?
Super-normal profit
When would a firm become a price maker?
If it has to cut price in order to sell more output and has to decide whether to set price higher or lower than market price
How does marginal revenue vary with market price for price makers?
MR always lower than market price - extra revenue gained from sale of another unit offset by loss of revenue from selling all units at lower price
How does MR curve relate to demand curve for price makers?
Twice as steep
When are profits maximised for price makers?
MC = MR at Q1P1
AR > ATC so firm makes super normal profits
How do we calculate marginal revenue for price makers?
Differentiate Total revenue/ quantity
a-2bQ
Define the principal-agent problem
P-A refers to tension between owner and manager:
Owner wants high profits and manager wants high pay
Manager wants high pay + quiet life - growth at expense of profitability
What is participation constraint?
The agent must earn enough in the bad state to make it worth his while to work (at the level the Principal wants)
What is Incentive Compatibility Constraint?
The agent must be better off honestly reporting a good state of nature and giving high effort than pretending that the state is bad and giving low effort
