Profit

Maximization
ECC 201 Intermediate Microeconomics Saree Worawisutsarakul

Profits Profits

Consider a firm producing one where

output using two inputs. y  amount of output
Production function: x1, x2  amounts of inputs
y  f ( x1 , x2 ) Let
p  output prices
1
w1, w2  input prices 2

Profits Short-run Profit Maximization

Profits: In the short run:

 There are some fixed factors,
  py  ( w1 x1  w2 x2 )
and the firm cannot adjust
 pf ( x1 , x2 )  w1 x1  w2 x2 the fixed factors in producing
output.

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Profit Maximization Page 1

ECC 201 Intermediate Microeconomics Saree Worawisutsarakul

Short-run Profit Maximization Short-run Profit Maximization

Suppose: Short-run profit maximization

 Factor 2 is fixed at x2 . problem:
max pf ( x1, x2 )  w1x1  w2 x2
Short-run production function: x1
y  f ( x1 , x2 ) F.O.C.
f ( x1 , x2 )
Short-run profits: p  w1  0
x1
  pf (x1, x2 )  w1x1  w2 x2 p MP1 ( x1, x2 )  w1
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Short-run Profit Maximization Short-run Profit Maximization


If x1 is the firm’s profit-maximizing Condition for Profit Maximization
choice of factor 1, then it must
 The condition for the firm’s
satisfy the condition:
profit-maximizing choice of a
factor can be derived by using
p MP1 ( x1 , x2 )  w1
graphs.
 The value of the marginal product
of factor 1 must equal its price.
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Profit Maximization Page 2

ECC 201 Intermediate Microeconomics Saree Worawisutsarakul

Short-run Profit Maximization Short-run Profit Maximization

Short-run production function: Short-run profits:

y  f ( x1, x2 )   py  w1 x1  w2 x2
 The maximum output that the firm Rewrite:
can produce from a given amount  w  w
of factor 1 and a fixed amount of y    2 x2   1 x1
factor 2 p p  p
f ( x1 , x2 ) intercept slope
 Slope   MP1
x1 9
 The isoprofit lines 10

Short-run Profit Maximization Short-run Profit Maximization

Isoprofit lines: Short-run profit maximization

 The set of all combinations of problem:
the input and the output that max py  w1 x1  w2 x2
x1 , y
gives a constant level of s.t. y  f ( x1 , x2 )
profit,  .  The problem is to find the point on
w1
 Slope  the production function that has the
p highest associated isoprofit line.
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Profit Maximization Page 3

ECC 201 Intermediate Microeconomics Saree Worawisutsarakul

Short-run Profit Maximization Short-run Profit Maximization

The firm’s profit is maximized at y

Isoprofit lines
the point where the isoprofit line
y  f ( x1 , x2 )
is tangent to the production 
y
function:
w1 

w2 Profit-maximizing choice
MP1 = p p
x2
p
 p MP1  w1 x1
x1
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Comparative Statics Comparative Statics

The firm’s profit-maximizing 1) Suppose: w1 

choice of the two inputs can  Isoprofit line gets steeper.
be affected by the change in: 
 x1 
 the input prices: w1 , w2
 the output price: p

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ECC 201 Intermediate Microeconomics Saree Worawisutsarakul

Comparative Statics Comparative Statics

Thus: y
high w1 low w1
As w1 increases, the demand y  f ( x1 , x2 )
for x1 decreases.
 The factor demand curve
must slope downward.
x1
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Comparative Statics Comparative Statics

2) Suppose: p  Thus:
 Isoprofit line gets flatter. As p increases, the supply
 x1  of y increases.
 The supply curve must
 y  slope upward.

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ECC 201 Intermediate Microeconomics Saree Worawisutsarakul

Comparative Statics Comparative Statics

y 3) Suppose: w2 
low p high p
y  f ( x1 , x2 )  Isoprofit line is unchanged.
 
 x1 , y are unchanged.
 x2 is fixed at x2 .
 Only π decreases.
x1
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Long-run Profit Maximization Long-run Profit Maximization

In the long-run: Long-run profits:

 The firm is free to choose   pf ( x1 , x2 )  w1 x1  w2 x2
all inputs to produce output.
Long-run profit maximization
Long-run production function:
problem:
y  f ( x1 , x2 ) max pf ( x1 , x2 )  w1 x1  w2 x2
x1 , x2
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ECC 201 Intermediate Microeconomics Saree Worawisutsarakul

Long-run Profit Maximization Long-run Profit Maximization

F.O.C. Rewrite (1) and (2):

f ( x1, x2 )
p  w1  0 (1) p MP1 ( x1 , x2 )  w1 (3)
x1
f ( x1 , x2 )
p MP2 ( x1 , x2 )  w2 (4)
p  w2  0 (2)
x2
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Long-run Profit Maximization Long-run Profit Maximization

The profit-maximizing choices Solving (3) and (4) yields

( x1 , x2 ) must satisfy the condition:
x1 ( p, w1, w2 )
p MP1 ( x1 , x2 )  w1
p MP2 ( x1 , x2 )  w2 x2 ( p, w1, w2 )
 The value of the marginal product of  Factor demand functions
each factor must equal its price.
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