Econ 14 Files
Econ 14 Lecture
Notes
Lecture 22: Profit Maximization
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Economics 14 |
Lecture 22: Profit Maximization
demand curve facing the firm
barriers to entry
finding profits graphically
Demand Curve Facing the Firm
We assume that firms choose the price and quantity produced so as to maximize profits. A firm's choices for the price and quantity produced depend on the environment in which it operates. One important factor is the demand curve facing the firm.
| With perfectly elastic demand the firm has no control over price. It only chooses the quantity to produce. |  |
 | A firm facing a downward sloping demand curve chooses both the price and quantity produced so as to maximize profits. |
| Facing a perfectly inelastic demand curve, the firm only chooses the price since the quantity is determined by how much consumers want. |  |
Firms would prefer to face the most inelastic demand curves possible. Firms can reduce elasticity by reducing the availability of substitutes. One way is to distinguish or differentiate your product from those of your competitors. Differentiation can occur through advertising, price, service, quality, location, et cetera.
Barriers to Entry
A firm's environment not only depends on the demand for its product but also on the ease of entry into the market.
A barrier to entry is anything that makes it difficult or costly for a firm to enter a market. Some barriers to entry are created by the government: patents and copyrighrs, zoning, and licensing are examples. Other barriers to entry are economic in nature. One such barrier to entry is fixed or sunk costs. These are costs which must be paid before any output is even produced.
- Airlines have huge fixed costs. An airline must lease planes, gtes at airports, and landing rights. They must tie into a computerized reservation system, and so on. These high fixed costs make it hard for new firms to enter the market. So airlines may make above-normal profits for a long time and can raise prices without fear of immediate new competition.
- Desktop publishing has low fixed costs: just a computer and a printer. It is easy for new firms to enter the market. Therefore, desktop publishers will not make above-normal profits for long.
Finding Profits Graphically
| TR = ABCD TC = EFCD Profits = ABFE |  |
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David A. Latzko Business and Economics Division Pennsylvania State University, York Campus office: 13 Main Classroom Building phone: (717) 771-4115 fax: (717) 771-4062 e-mail: web: www.yk.psu.edu/~dxl31 |
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