Chapter Outline

The goal of profit maximization must be understood in light of the concepts of economic, accounting, and normal profit.
1. Over a long period of time, selective pressures in the competitive environment drive firms to profit maximize.
2. Profit maximizers have better access to credit because bankers attempt to minimize their risks.
3. Managers are sometimes rewarded by profit sharing and so have incentive to maximize profit.
Perfect competition requires a standardized product, mobile resources, perfect information, and price-taking firms.
Short-run profit maximization is achieved when the difference between total revenue and total cost is the greatest, which is also the point where marginal revenue equals marginal cost.
A firm should shut down if the market price it receives does not cover the average variable costs of production.
1. As price varies above the shut-down price, the firm will supply output as indicated by its marginal cost curve, so the marginal cost curve is the firm's supply curve.
2. The horizontal summation of the individual firm's supply curves is the industry supply curve.
In short-run equilibrium all firms are profit maximizing.
1. Economic profits or losses can exist in the short run.
2. Resources are efficiently allocated at equilibrium.
Producer and consumer surplus represent the net benefits that the market generates. This is maximized at the equilibrium price where marginal benefits (price) equal marginal costs.
In the long run, firms can adjust plant size or shut down.
1. Optimal plant size for a firm exists where price equals long-run and short-run marginal cost.
2. Because of entry and exit possibilities, final long-run equilibrium exists where price equals marginal cost at the minimum point of the long-run average cost curve.
3. When working effectively, the market acts as an invisible hand, coordinating enormously complicated information that channels resources to their best use.
The long-run supply curve can take many shapes.
1. If resource prices are constant and LAC curve is U-shaped, the long-run supply curve will be horizontal.
2. If the LAC is horizontal, the long-run supply curve will be horizontal, but the number and size of the firms will be indeterminate.
3. The long-run supply curve will be positively sloped if pecuniary diseconomies are present and negatively sloped if pecuniary economies exist. In the first case will say that the market is characterized as an increasing cost industry while in the second case the industry is a decreasing cost industry.
4. Supply price elasticity measures the sensitivity of the quantity supplied to price changes.
The problem of supporting the family farm, the illusory attraction of taxing business, and the adoption of cost-saving devices all provide examples of the competitive market principle at work.
Adam Smith’s insight was that in an ideal competitive market, individuals and firms, driven by their own self interest and using price signals, arrive at the long run equilibrium position where the general social welfare is promoted although no firms based its own actions on anything other than maximizing its own profits.

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