Total Cost at Q=20 is $95.25
Profit = $200 - 95.25 = 104.75
Profit can be computed using Average Cost
Profit per unit = Price - Average Cost
Total Profit = Profit per unit x Quantity
Profit per unit = $10.00 - $4.76 = $5.24
Total Profit = $5.24 x 20 = $104.80
At a price of $10 is there a more profitable level of production than 20 units?
|
Q |
Total Cost |
Ave Cost |
Marginal |
Profit |
|
19 |
90.25 |
4.75 |
4.08 |
99.75 |
|
20 |
95.25 |
4.76 |
5.00 |
104.75 |
|
21 |
101.33 |
4.83 |
6.08 |
108.68 |
|
22 |
108.63 |
4.94 |
7.30 |
111.38 |
|
23 |
117.30 |
5.10 |
8.68 |
112.70 |
|
24 |
127.50 |
5.31 |
10.20 |
112.50 |
|
25 |
139.38 |
5.58 |
11.88 |
110.63 |
|
26 |
153.08 |
5.89 |
13.70 |
106.93 |
Profit = Total Revenue - Total Cost
At Q=23 ¹ = 230.00 - 117.30 = 112.70
Compare changes in Profit to the difference between $10.00 and Marginal Cost.
|
Q |
Total Cost |
Ave Cost |
Marginal |
Profit |
|
21 |
101.33 |
4.83 |
6.08 |
108.68 |
|
22 |
108.63 |
4.94 |
7.30 |
111.38 |
|
23 |
117.30 |
5.10 |
8.68 |
112.70 |
|
24 |
127.50 |
5.31 |
10.20 |
112.50 |
|
25 |
139.38 |
5.58 |
11.88 |
110.63 |
Continue producing until Marginal Cost equals Price.
As long as Marginal Cost is below Price additional units contribute to Total Profit.
Maximize Profit at Q for which P = MC
Maximize Profit at Q for which P = MC
What will other companies do if they see these supra-normal profits?
They will enter the market. They will offer the same product at a slightly lower price, but still make an abnormal profit.
If profits persist, other firms will enter and will also offer a lower price to consumers.
Entry will continue until companies sell the good for $4.75 per unit and each company produces 19 units.
Entry lowers Price
Higher Supply is sold only at a lower Price
The Efficiency of Competitive Entry
Every firm must produce in the most efficient manner or they will lose money.
Consumers will pay the lowest possible price for the good.
The Benefits of Competition
It forces companies to adopt the most efficient production processes and make the most efficient use of resources.
It drives Price to the lowest level at which production can be maintained (which allows companies to make a normal profit).
Low prices let consumers spread their income over more goods, so increases their happiness.
Assumptions for Perfect Competition
• Commodity-like Good - consumers can easily change suppliers.
• Consumers consider only Price when deciding which firm to buy from.
• Many small producers and many buyers none of whom can affect price. Price-taking behavior - take prices as given.
• Easy entry and exit from the market.
• Information about goods and prices is freely available.
Types of Costs
Fixed Costs - Machines, Factory Size
Can be varied only in the long-run
In the short-run these cannot be varied.
Variable Costs - Labor, Materials
Can be varied in the short-run.
Specialized machinery lowers production costs but reduces short-run flexibility.
E.g., a computerized machine costs more to buy but less to operate. If sales drop there is no labor to adjust. You are stuck with the expensive machine.
Low versus High Fixed Costs
