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PlotIT - Profit maximisation

As we saw earlier, profit maximisation will occur for a firm where MC=MR. The following diagram shows the costs and revenues for a product Y over a range of output from zero to 80 units per week. Product Y is one of many products produced by the firm. The fixed costs associated with producing Y are 120 per week, 60 of which is normal profit.

slomanecon_c03_l05_5

What happens when the demand for a firm's product changes? How will this affect the profit maximising price and output? The following diagram is the same as the one above. It shows the cost and revenue curves for firm X in the production of good Y.

Now assume that a close competitor of product Y has dropped the price of its product. As a result demand for product Y changes by 15 units per week.

In the diagram below, click on the two points in turn where the new AR curve strikes the axes. Then do the same for the MR curve.

You may like to check your answer.

question

1

Shift in demand

Given the drop in demand faced by the firm, what is the new equilibrium profit maximising output and price? How much profit is the firm making at this equilibrium?

The new equilibrium output will be at 25 units (where MR = MC - profit maximising).The equilibrium price will be 12.00.

At this equilibrium, the firm will be making just normal profit, since AR = AC. In other words, supernormal profit is zero.

Check your answer