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Main content
Current time:0:00Total duration:5:00
CBA‑2 (EU)
CBA‑2.D (LO)
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Video transcript

we've spent several videos talking about the costs of a firm and in particular we've thought about how marginal cost is driven by quantity and how average total cost is driven by quantity and we think about other average costs as well now in this video we're going to extend that analysis by starting to think about profit now profit you are probably already familiar with the term but one way to think about it very generally it's how much a firm brings in you could consider that its revenue - its costs - its costs and a rational firm will want to maximize its profit and so to understand how a firm might go about maximizing its profit or what quantity you would need to produce to maximize its profit based on this on its cost structure we have to introduce revenue into this model here and in particular we are going to introduce the idea of marginal revenue and we're going to assume that this firm is in a very competitive market and so it is a price taker so regardless of how much of this firm produces the incremental revenue per unit of what it produces maybe this is a doughnut company the incremental amount per doughnut is going to stay the same regardless of how much this firm in particular produces so let's say that the marginal revenue in this industry in this market is right over here so one way to think about it is this would be the unit price in that market so let me put that right over there marginal revenue once again for every incremental unit how much revenue you are going to get so it would just be the price of that unit so how much would a rational firm produce in order to maximize its profit if the marginal revenue is higher than the marginal cost well that means every incremental unit it produces it's going to bring in some net money into the door so it's rational for it to do it so it would keep producing keep producing keep producing keep producing now it gets interesting as the marginal cost starts to approach the marginal revenue as long as the marginal revenue is higher than the marginal cost it's rational for the firm to produce but right at that unit where the marginal cost is equal to the marginal revenue well there on that incremental unit the firm just breaks even at least on the margin it might be able to utilize some of its fixed costs a little bit but then after that point it makes no sense at all for it to keep producing why is that well the marginal cost is higher than the marginal revenue that would be like saying hey I'm gonna sell a doughnut for $1 even though that incremental doughnut costs me $1 tend to produce well no rational person if they want to maximize the profit would do that so a rational firm that's trying to maximize its profit will produce the quantity where marginal cost intersects marginal revenue it will produce this quantity right over there now a natural question might be how much profit will it make from producing that quantity well all you have to do is think about this is the marginal revenue that it gets and another way you could think about it because this is constant it's also going to be the average revenue that it gets per unit and this right over here is the average total cost per unit and so what you could do is this is how much it's getting on average per unit and then multiply that times the number of units and what you get is the area of this rectangle so for those of you who are more visually inclined one way to think about it is a profit maximizing firm a rational profit-maximizing firm would want to maximize this area think about what would happen if they only produced this much well then they're giving up a ton of area then the rectangle would only be this big this would be the profit that the firm is going to be making from those units and then if it decides for some irrational reason to produce more than this quantity that we settled on before let's say this right over here notice even though that the base of this rectangle is long the height is less and this would actually have a lower area and the reason why I feel very confident that this will have a lower area is because in this situation the firm is losing money on all of these incremental units where the marginal cost is higher than the marginal revenue so big take away a rational firm that's trying to maximize its profit will produce the quantity where marginal cost and marginal revenue are equal to each other