Download Profit Maximization by a Perfectly Competitive Firm

Profit Maximization by a Perfectly Competitive Firm
Output
(Q)
Bushels
of
Carrots
Price
(P) per
bushel
0
$11.00
1
$11.00
$22.00
2
$11.00
$27.50
3
$11.00
$34.00
4
$11.00
$42.00
5
$11.00
$53.00
6
$11.00
$65.00
Total
Revenue
(P x Q)
Marginal
Revenue
(TR/Q)
Average
Revenue
(TR/Q)
Total
Cost
Average
Total
Cost
(TC/Q)
Marginal
Cost
(TC/Q)
---
---
$16.00
---
---
Total
Profit (T)
(TR – TC)
Directions:
1) Complete the chart using the information provided.
2) What do you notice about price, marginal revenue, and average revenue?
3) On a sheet of graph paper, plot the values for MR, MC, & ATC on a graph. Label the
axes and each curve. You should have Q on the X-axis and $ on the Y-axis. The MR
curve is also the firm’s demand curve, which for perfect competition is perfectly
elastic (horizontal). (The y-axis scale should simply be $1 per square. The x-axis scale
should be stretched out, with one output level per four squares.)
4) Locate the point where MR = MC on the graph. Draw a dashed vertical line from this
point down to the X-axis. This is the level of output the firm will choose, where
marginal revenue (which the firm sees as marginal benefit) is equal to marginal
cost. Record this optimal quantity of output here. What price will the firm charge?
5) Using the quantity you identified in #4, shade the rectangular area of total revenue (P x
Q) very lightly. Record the amount of total revenue.
6) Locate the point where ATC intersects your dashed line from the profit-maximizing
quantity. Draw a horizontal line from this point over to the Y-axis. Shade the rectangular
area above this line up to MR using diagonal lines. This rectangle is total profit! The
area below profit down to the x-axis represents total cost. Record the amounts of T &
TC.
In this scenario, the profit-maximizing output allows the firm to make a positive economic profit
(scenario 1 below). This isn’t always the case. You need to know the following scenarios:
1. If P > ATC,  > 0.
2. If P < ATC,  < 0.
3. If P = ATC,  = 0.
Profit Maximization by a Perfectly Competitive Firm
Output
(Q)
Bushels
of
Carrots
0
Price
(P) per
bushel
$6.50
Total
Revenue
(P x Q)
Marginal
Revenue
(TR/Q)
Average
Revenue
(TR/Q)
Total
Cost
Average
Total
Cost
(TC/Q)
Marginal
Cost
(TC/Q)
---
---
$16.00
---
---
1
$6.50
$22.00
2
$6.50
$27.50
3
$6.50
$34.00
4
$6.50
$42.00
5
$6.50
$53.00
6
$6.50
$65.00
Total
Profit (T)
(TR – TC)
Now, a super-vegetable has become popular, causing people to buy that instead of carrots, so
the carrot market suffers a dramatic decrease in demand, and the market price falls to $6.50
per bushel.
1) Complete the chart using the new price.
2) Plot the new MR, MC, & ATC curves on a new graph (same scale as before).
3) Locate the point where MR = MC on the graph. Draw a dashed vertical line from this
point down to the X-axis. This is the level of output the firm will choose, where
marginal revenue (which the firm sees as marginal benefit) is equal to marginal
cost. Record the quantity. What price will the firm charge?
4) Using the quantity you identified in #4, shade the rectangular area of total revenue (P x
Q) very lightly. Record the amount of TR.
5) Continue your dashed line up to the point where it intersects ATC. Draw a horizontal
line from this point over to the Y-axis. Shade the rectangular area below this line down
to MR using diagonal lines. This rectangle is total profit, but this time it is a negative, a
loss (scenario 2 from the front page). The area from your highest horizontal line down to
the X-axis represents total cost. Record the amounts of T & TC.
If a firm is incurring losses, there comes a point when it must decide whether it’s economically
rational to continue to operate at all. There are general rules that help a firm make this
decision. In the short run, a firm will continue to operate if:
A. Positive profits are being made.
B. Losses are smaller than fixed costs.
In the short run, a perfectly competitive firm will remain open when


MR=D=AR=P is above the ATC curve or,
MR=D=AR=P is below the ATC curve but above or equal to the AVC curve.
In the short run, a firm will shut-down when MR=D=AR=P is below the AVC curve.
6) Will this firm continue to operate once the price decreases to $6.50? Why or why not?