Short-Run Profit Maximization

Definition

Short-run profit maximization refers to the goal of a firm to maximize its profits in the short-term, typically by adjusting its output level to the point where marginal revenue equals marginal cost. This strategy is particularly relevant in the context of perfect competition, where firms are price-takers and must make production decisions based on market conditions.

5 Must Know Facts For Your Next Test

1. In the short-run, a firm's production is limited by its fixed factors of production, such as capital equipment and facilities.
2. Profit maximization occurs when the firm produces the output level where the difference between total revenue and total cost is greatest.
3. The firm's short-run supply curve is the portion of its marginal cost curve above the minimum point of its average variable cost curve.
4. In perfect competition, the firm's demand curve is perfectly elastic, meaning it can sell any quantity at the market price.
5. Profit maximization in the short-run requires the firm to produce the output level where marginal revenue equals marginal cost.

Review Questions

• Explain how a firm in perfect competition determines its short-run profit-maximizing output level.
  • In perfect competition, a firm determines its short-run profit-maximizing output level by producing the quantity where its marginal revenue (which is equal to the market price) equals its marginal cost. This occurs at the output level where the difference between total revenue and total cost is greatest, allowing the firm to maximize its profits in the short-run. The firm's supply curve in the short-run is the portion of its marginal cost curve above the minimum point of its average variable cost curve.
• Describe how a firm's fixed and variable costs impact its short-run profit maximization decisions.
  • In the short-run, a firm's production is limited by its fixed factors of production, such as capital equipment and facilities. The firm's variable costs, which include expenses like labor and raw materials, can be adjusted to influence the firm's output level and profitability. To maximize short-run profits, the firm will produce the output level where the difference between its total revenue and total variable cost is greatest, subject to the constraints of its fixed costs. This requires the firm to produce the quantity where its marginal revenue equals its marginal cost.
• Analyze how the perfect competition market structure affects a firm's short-run profit maximization strategy.
  • In a perfectly competitive market, firms are price-takers, meaning they have no control over the market price. As a result, a firm's marginal revenue is equal to the market price, and its demand curve is perfectly elastic. To maximize short-run profits, the firm must produce the output level where its marginal revenue (the market price) equals its marginal cost. This allows the firm to sell any quantity at the prevailing market price and earn the greatest possible profit in the short-run, given its production constraints and cost structure.

Related terms

Marginal Revenue:

The additional revenue a firm earns by producing and selling one more unit of output.

Marginal Cost:

The additional cost a firm incurs by producing and selling one more unit of output.

Perfect Competition:

A market structure where firms are price-takers, there is perfect information, and there are no barriers to entry or exit.