Chapter 8

Question 1

1. Explain and justify the assumption that firms maximize profit.

Answer 1

The firm

a. A single economic decision maker
b. Goal: to maximize its owners’ profit
c. Decisions
i. What price to charge
ii. How much to produce

Question 2

Economic profit

Answer 2

a. Proper measure of profit: for understanding and predicting the behavior of firms
b. Recognizes all the opportunity costs of production
i. Explicit costs and implicit costs

Question 3

Account profit VS economic profit

Answer 3

Accounting profit – Total revenue minus accounting costs

Economic profit – Total revenue minus all costs of production, explicit and implicit.

Question 4

. Describe the revenue and cost constraints faced by firms.

Answer 4

4
Total Revenue and Elasticity
a. Lower price: sell more output
i. If ED > 1 (elastic demand): total revenue will rise
ii. If ED < 1 (inelastic demand): total revenue will fall
The cost constraint (minimizing costs)
b. Given production technology
c. Firm must pay prices for each of the inputs that it uses

Question 5

total revenue/total cost approach and the marginal revenue/marginal cost approach (including tables and graphs) to explain how a firm finds its profit-maximizing output level.

Answer 5

Total Revenuek – The total inflow of receipts from selling a given amount of output.
• TC and TR approach using graphs
– Maximize profit
– Produce the quantity of output where the vertical distance between the TR and TC curves is greatest
– And the TR curve lies above the TC curve
• MC and MR approach using graphs
– Maximize profit
– Produce the quantity of output closest to the point where MC = MR
• MC and MR curves intersect
• MC curve crosses the MR curve from below

Question 6

Marginal approch to profit and marginal revenue

Answer 6

Marginal approach to profit – A firm maximizes its profit by taking any action that adds more to its revenue
Marginal revenue – The change in total revenue from producing one more unit of output.

Question 7

Shutdown rule

Answer 7

the firm should continue to produce if the total revenue exceeds total variable costs; otherwise, it should shut down. Shutdown price – the price at which a firm is indifferent between producing and shutting down.

Question 8

Exit rule

Answer 8

– A permanent cessation of production when a firm leaves an industry

Question 9

Demand curve facing firms –

Answer 9

a curve that indicates, for different prices, the quantity of output that customers will purchase from a particular firm