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Profit and the Firm What is profit? Profit = Total Revenue – Total Costs Price. Q – Total Costs Total Costs = Total Explicit Costs – Total Implicit costs Business Profit = TR – T. Explicit Costs • When economic profit is equal to zero, business profit is equal to “normal” profit. • When a firm is making less than a normal profit it may consider leaving the industry in long run while it may continue operation in the short run Profit and the Firm • A business firm’s primary objective is making profits • A firm that cannot remain profitable loses its value and will eventually fail. • Investors may tolerate or even accept temporary losses in the hope of higher future profits, but there is a limit to their patience. » The demise of many internet and technology companies in recent years is a good example of investors’ disappointment in companies that fail to show a profit. Profit: A Simple Case = TR - TC TR = P. Q ; P = Constant TC = TFC + AVC . Q ; AVC = MC Or TC = AFC . Q + AVC . Q = P.Q - AFC . Q - AVC .Q Or we can write: Profit = PQ - TFC - AVC.Q = Break-even Q: Profit Zero PQ -TFC -AVC.Q = 0, or Q(P-AVC) = TFC TFC Q b = ------------P -AVC Break-Even Quantity TR = P.Q $ TC = TFC +AVC . Q TFC’ TFC 0 Qb Q’b Q Profit: The Case of Increasing TC Marginal Cost Profit = P.Q - TC (Q) TR $ MR MC o Q Profit: The case increasing marginal cost and downward-sloping demand $ TC MR TR MC Q o Q1 Q2 Q3 $ The Profit Function Marginal Profit = 0 Q Q* Profit Profit-Maximizing Rule • • • • • • • Set marginal profit = zero Set MR = MC Set Price = MC (Perfect Competition) Set LMC = MR Set LMC = Price (Perfect Competition) Set MRPL = Wage Set MRPK = Rent