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- [Alex Taborrok] In the next 
set of videos,

we'll be looking at costs 
and how to describe a firm's costs.

We'll also take a look at how
a firm maximizes its profit.

In this section, we're looking at

profit maximization 
under competition.

In a later section, we'll cover

profit maximization 
under monopoly.

Let's get going.

So the key question that 
we want to answer is this,

"How do firms behave?"

And a guiding assumption is 
going to be that

profit is the main motivation 
for a firm's actions.

Now this is not literally 100% true.

Nevertheless, for most firms, 
most of the time,

profit is going to be 
a key motivator.

For firms with a lot of competitors,
competition alone is going

to compel them to maximize profit

because firms with 
a lot of competitors

that don't maximize profit,

they're going to be 
out of business pretty quickly.

For firms with more market power 
or monopoly power --

they're not compelled 
to maximize profit.

Nevertheless, the owners 
are still going to want profit.

Who doesn't like profit?

So for most firms, 
most of the time,

this is going to be 
a good assumption.

The key question then becomes, how?
How do firms maximize profit?

And the basic answer is
by choosing price and quantity.

By choosing what price is set 
and what quantity to set.

Now some firms have more control 
over their price than others.

In the next chapter, we're going 
to be looking at a monopoly,

which can choose price and quantity
with some restrictions.

In this chapter, we're going 
to be looking at a competitive firm,

which takes prices as given --

it doesn't have much control 
over its price --

we'll explain why in a moment, 
and it chooses quantities.

So for a competitive firm,

quantity is going to be 
the key choice

which determines how much profit 
the firm makes.

So we're focusing in this chapter 
on one type of firm,

the competitive firm, 
the firm in a competitive market.

Now what are the characteristics 
of this firm and market?

Well, the product that 
the firm sells

is similar across 
many different sellers.

So think about 
this stripper oil well.

This small oil well, 
it produces oil,

which is pretty much the same

as the oil produced 
by the well next door,

which is pretty much the same

as the oil produced 
by a well in Saudi Arabia,

which is pretty much the same 
as the oil produced from Mexico

or from the North Sea and so forth.

Oil is pretty much the same
across all over the world.

Or think about wheat, or soy beans,
or steel, or concrete, or paper.

All of these are 
competitive markets --

the product is similar 
across sellers.

In addition, in all 
of these markets

there are many buyers and sellers

and they're each small relative 
to the total market.

So this stripper oil well produces
only a small fraction

of the world's 
total production of oil.

A wheat farm, any given wheat farm

produces only a small fraction 
of the total production of wheat.

Alternatively, we may have the case

where there are 
many potential sellers.

So even if a firm, a grocery store 
in a small town,

is the only grocery store 
in the small town,

it's still in a competitive market,

because if it were 
to raise its price,

there are many potential sellers

who in the long run 
could sell in that same town.

So that's a competitive firm.

It's producing a product 
which is similar across sellers,

there are many buyers and sellers,

each small relative 
to the total market,

or there are 
many potential sellers.

So let's suppose you own one of
those stripper oil wells

I showed in the previous slide.

What price are you going to set?

Well, fortunately your problem 
is going to be really easy

because a firm 
in a competitive market

has no control over its price.

The market determines 
each firm's price.

So let's take a look at 
the market for oil,

and suppose that the world demand 
and supply

are such that quantity 
demanded is equal

to quantity supplied
at a price of $52,

at which point 82 million barrels 
of oil a day are bought and sold.

Now let's think about 
the demand for your oil.

The oil produce 
by your stripper oil well.

The demand for your oil

is going to be perfectly elastic 
at the market price.

Now what does that mean?

What that means is suppose that 
you tried to sell your oil

at a price above the market price,

let's say $55 per barrel.

Are you going to sell any oil?
No!

Not even your mother thinks that
the oil from your well

is so special that she would be 
willing to pay more for it.

She can get oil which is identical 
or virtually identical

at a price of $50 per barrel,

so she's unlikely 
to be want to pay $55.

And if your mother won't 
pay extra then nobody will.

So if you try to set a price higher
than the market price,

you're not going to sell 
any oil at all, zero.

Now you can sell as much oil 
as you want below the market price,

but why would you want to do that?

Because in fact you could sell

all the oil you want 
at the market price.

Now why can you sell all the oil
that you want at the market price?

Simply because your production,

let's say 10 barrels a day, 
or 20 or 30,

it's so small relative 
to the world production

of 82 million barrels of oil per day,

that however much you produce 
from your single well,

that's not going to influence 
the price of oil.

So you can double, triple 
your production,

the price of oil is still going 
to $50 per barrel.

So your only choice, 
then to maximize profit

is going to be a choice over quantity.

You look at the market price,

you see, "Oh the price of oil today
is $50 per barrel,"

and your decision is going to be

how much do I want to produce 
at that price?

Do I want to produce 2 barrels, 
3 barrels, 4, 10, 20, how much?

That is going to be 
your key question,

and that's the key question 
we'll take up next time

when we also add into this diagram 
your costs.

- [Announcer] If you want to test
yourself,

click "Practice Questions."

Or if you're ready to move on,
just click, "Next Video."

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