Download price-taking firm`s optimal output rule

Microeconomics in Modules
and
Economics in Modules
Third Edition
Krugman/Wells
Module 25
Perfect Competition
What Will You Learn
1
How a price-taking firm determines its
profit-maximizing quantity of output
2
How to assess whether a competitive firm
is profitable
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Maximizing Profit
TR = P × Q
Profit = TR – TC
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Maximizing Profit
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Using Marginal Analysis to Choose the
Profit-Maximizing Quantity of Output
• Marginal revenue is the change in total revenue
generated by an additional unit of output.
MR = ∆TR/∆Q
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The Optimal Output Rule
• The optimal output rule says that profit is
maximized by producing the quantity of output
at which the marginal cost of the last unit
produced is equal to its marginal revenue.
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Short-Run Costs for Jennifer
and Jason’s Farm
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Marginal Analysis Leads to ProfitMaximizing Quantity of Output
• The firm’s optimal output rule says that a firm’s
profit is maximized by producing the quantity of
output at which the marginal cost of the last unit
produced is equal to the market price.
• The marginal revenue curve shows how marginal
revenue varies as output varies.
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Production and Profits
• The price-taking firm’s optimal output rule says
that profit is maximized by producing the quantity
of output at which the marginal cost of the last unit
produced is equal to the market price.
• The marginal revenue curve shows how marginal
revenue varies as output varies.
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Short-Run Costs for Jennifer and
Jason’s Farm
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The Price-Taking Firm’s ProfitMaximizing Quantity of Output
Price, cost
of bushel
MC
Optimal
point
$24
20
E
Market 18
price 16
The profit-maximizing point is
where MC crosses MR curve at
an output of 5 bushels of
tomatoes.
12
8
6
0
MR = P
1
2
3
4
5
6
Profit-maximizing
quantity
7
Quantity of tomatoes
(bushels)
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When Is Production Profitable?
• If TR > TC, the firm is profitable.
• If TR = TC, the firm breaks even.
• If TR < TC, the firm incurs a loss.
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Short-Run Average Costs for Jennifer
and Jason’s Farm
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Costs and Production in
the Short Run
Price, cost
of bushel
$30
MC
Minimum average
total cost
18
Market
price
ATC
C
14
MR = P
At point C (the minimum average total cost),
the market price is $14 and output is four
bushels of tomatoes (the minimum-cost
output).
0
1
2
3
4
Minimum-cost
output
5
6
7
Quantity of
tomatoes (bushels)
This is where MC cuts the ATC curve at its minimum.
Minimum average total cost is equal to the firm’s break-even price.
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Profit, Break-Even or Loss
• The break-even price of a price-taking firm is
the market price at which it earns zero profits.
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Profit, Break-Even or Loss
• Whenever market price exceeds minimum
average total cost, the producer is profitable.
• Whenever the market price equals minimum
average total cost, the producer breaks even.
• Whenever market price is less than minimum
average total cost, the producer is unprofitable.
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Summary
1. A producer follows the optimal output rule:
produce the quantity at which marginal revenue
equals marginal cost.
2. For a price-taking firm, marginal revenue is equal to
price, and its marginal revenue curve is a
horizontal line at the market price. It follows the
price-taking firm’s optimal output rule: produce
the quantity at which price equals marginal cost.
3. A firm is profitable if total revenue exceeds total
cost.
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