Short Run Profits using TR and TC

Maximum profits will occur at the output level where there is thegreatest vertical distance between TR and TC, when TR>TC. In Figurethe TR and TC functions for a firm are shown. The TR is astraight line (with a constant slope). TR is price times quantity. SinceTR is a linear function this implies that the price for all quantities arethe same, the firm is in a purely competitive market (the demand isperfectly elastic at the market price.). MR is defined as the change inTR associated with a change in Q. MR is the slope of TR, so MR is theprice.

The TC intercept is at W, which is the fixed cost and shows that this is agraph depicting a short run condition. The TC function increases at adecreasing rate that implies that MC is falling and MP of the variableinput is rising. Beyond the inflectionpoint in the TC, TC increases at anincreasing rate. The model shows“break-even” points (A and C) atoutput level QA and QC. At these breakevenpoint the firm is earning a normalprofit. (Remember normal profits areincluded in the cost functions.)

Between output levels QA and QC, theTR>TC. This means that economicprofits (Π) exist. Maximum Π occur atoutput level QB., the greatest verticaldistance between TR and TC. Note thatat point A (producing QA) the firmobtains a normal profit. If they produceand additional unit the MC (slope of TCat point A) is less than the slope of the

TR (MR), i.e. they can produce additional units for less than someone is willing to pay for them. At output level QB, the slope of the TC (MC) is equal to the slope of the TR (MR). If they attempt to increase output above QB, the cost of additional units (shown by the slope of the TC) increases faster the increase in TR (shown by the slope to TR). Where the slope of the TC (MC) is the same as the slope of the TR (MR), profits (the vertical distance between TR and TC) are maximized.