CHAPTER8PROFITMAXIMIZATIONANDCOMPETITIVESUPPLYTEACHINGNOTESThischapteridentifiesthebehavioralincentivesoftheprofit-maximizingfirmandthenexplorestheinteractionofthesefirmsinacompetitivemarket.Eachsectionofthechapterisimportantandbuildsasolidunderstandingofthesupplysideofthecompetitivemarket.ItisnecessarytobuildthisfoundationbeforemovingontothechaptersinpartIIIofthetext.Whilethematerialinthechapteriswritteninaveryclear,easytounderstandmanner,studentsstillstrugglewithmanyoftheconceptsrelatedtohowthefirmshouldchoosetheoptimalquantitytoproduce,andhowtoapplythecostcurvediagramlearnedinthepreviouschapter.Oneoptionforlectureistospendtimeworkingwithatablesimilartotheoneusedintheexercisesattheendofthechapter.Workingthroughmanyexampleswiththistypeofatablecanhelpthestudentsunderstandthedifferenttypesofcost,aswellasthefirm’soptimallevelofproduction.Section8.1identifiesthethreebasicassumptionsofperfectcompetitionandsection8.2discussestheassumptionofprofitmaximizationasthegoalofthefirm.Bothsectionsareimportantinbuildingthefoundationforderivingthefirm’ssupplycurve,whichisdoneinsections8.3to8.5.Section8.3derivesthegeneralresultthatthefirmshouldproducewheremarginalrevenueisequaltomarginalcost.Thesectionthengoesontoidentifyperfectcompetitionasaspecialcasewherepriceisequaltomarginalrevenue,whichfollowsdirectlyfromtheassumptionofpricetakerbehaviorinsection8.1.Ifyourstudentshavehadcalculus,itishelpfultoderivethemarginalrevenueequalsmarginalcostrulebydifferentiatingtheprofitfunctionwithrespecttoq.Ifyourstudentshavenothadcalculusthenitishelpfultodosomemoreworkwiththedatatablessotheyunderstandthatprofitismaximizedwhenmarginalrevenueequalsmarginalcost.Emphasizethattheperfectlycompetitivefirmchoosesquantityandnotpriceinordertomaximizeprofit.Toputperfectcompetitioninperspective,itcanalsobehelpfultogiveabriefoverviewofmonopoly,oligopoly,andmonopolisticcompetitionbeforepresentingtheassumptionsofperfectcompetition.Restrictthisdiscussiontoidentifyinghowmanyfirmsareintheindustry,iftherearebarrierstoentry,productdifferentiation,andwhatassumptionsdoeseachfirmmakeabouthowtheotherfirmsintheindustrywillreacttotheirpriceandquantitydecisions.Thiswillstimulatethestudent’sinterestaboutupcominglectures.Sections8.4and8.5furtherexplorethefirm’sdecisiontoproducewherepriceisequaltomarginalcost,andshowthatthefirm’ssupplycurveisitsmarginalcostcurveaboveitsaveragevariablecostcurve.Althoughsomestudentswillunderstandreferencestosecond-orderconditions,expecttobeaskedwhyq0inFigure8.3isnotprofitmaximizing,althoughMR=MC.Twoadditionalpointswarrantcarefulexplanation:1)whythefirmwouldremaininbusinessifthefirmsustainsalossintheshortrun,and2)thatmaximizingprofitisthesameasminimizingloss.Althoughthesummationoffirmsupplycurvesintoamarketsupplycurveisstraightforward,theanalysisoflong-runcompetitiveequilibriumisdifficult.Difficultconceptsinclude:*whyitmaybeoptimalforthefirmtoincurlossesintheshortrunbutnotthelongrun.*whyfreeentryandexitwillreduceeconomicprofittozerointhelongrun.*whypriceisequaltominimumaveragecostinthelongrun.Itcanbehelpfultopresentanexample,algebraicandgraphical,whichstartsoutwithonlyonefirmintheindustrythatisearningpositiveeconomicprofit,andthenshowhowthemarketwillconvergeonitslongrunequilibriumpoint.Explorechangesinprice,quantityproduced,andthelevelofprofits,andrelatethechangestothefirm’sbehavioralmotivations...
