In the last chapter, we saw how the short-run production decisions of the firm are made. In this chapter, we will extend that analysis to specifically address the question of how firms maximize profits.
We will fully explore the different types of costs faced by firms, and then examine how revenue changes with production decisions. Finally, we will put these concepts together to find a short-run production strategy for the perfectly competitive firm that maximizes profit. By the end of this chapter, you should be able to answer the following questions:
1. How do you know if a cost of production is fixed or variable?
2. How can you find the cost curves and revenue curves given the production function and market conditions? Can you explain what each curve means in a non-technical way?
3. Why do the average total cost and average variable cost curves get closer together as output increases?
4. Why is the marginal cost curve U-shaped?
5. Why is marginal revenue constant for a perfectly competitive firm?
6. What is a perfectly competitive firms short-run profit-maximizing strategy and why?
7. How is the firms profit-maximizing quantity affected when there is a change in fixed cost or a change in variable cost?
8. What is the explanation for the upward sloping supply curve?