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Tutorial 9: Firms With No Market Power (cont.)

 

Choosing Output in the Short Run

A firm's goal is to maximize economic profit. As we have just seen, economic profit is at its highest when the marginal cost of the last unit produced equals the price of the last unit sold. In Figure 2, the profit-maximizing level of output for this price-taking firm is shown at q*, 27 units/t, where MR1 = MC1. We know this output will generate the highest economic profit possible for the firm, but how high is it? Just because economic profit is at a maximum does not mean it is large -- or even positive!

 

Figure 2


Graph of MR, MC & ATC, showing price-taking firm's profit-maximizing level of output.

Earlier in this Tutorial we wrote out the total economic profit equation as:

P(Q) = R(Q) - C(Q),

which we can rewrite as P(Q) = P · Q - ATC(Q) · Q. Factoring out Q, this leaves us with the following:

P(Q) = [P - ATC(Q)] · Q.

So total profit can be calculated as the difference between price and average cost times the level of output sold. Graphically, we can find the ATC(q*) by drawing a vertical line up from the profit-maximizing output level, q*, until it reaches the ATC curve. Then continue that line horizontally to the left until it reaches the vertical axis. The point at which that line hits the vertical axis tells us the average total cost of producing q*. The shaded rectangle (P* - AC*) · q* shows the size of the economic profit earned by this firm from the sale of q* units of output at a market price of P*. According to the Excel workbook for this Tutorial, that economic profit amounts to just over $1100.

 

Figure 3


Graph showing positive economic profits at the firm's profit-maximizing level of output.

Now it's time for you to open the Excel workbook for this Tutorial, vary market price, and see what happens to the firm's maximum economic profit as price changes.

 

Now it's time to "do the thing".

Click on the following link to download the Perfectly Competitive Firm Workbook. Work through Questions 1 - 3. This will help you improve your understanding of how a price-taking firm chooses output so as to maximize economic profit in the short run. 

Return here when you have finished.

Need help downloading the Excel file?

 

This is a good time to start, or continue, GFE 19... This one takes a while to complete.

 

S0 far we have discovered that a firm seeking the maximum economic profit will adjust output so that the marginal cost of the last unit produced equals the marginal revenue from the sale of that output. Once output is set, the firm calculates economic profit by multiplying the difference between the price it charges and the average total cost of producing the last unit by its output level.

In the next part of Tutorial 9 we explore the firm's short run and long run responses to an economic profit that is negative.