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!
Earlier in this Tutorial we wrote out the total economic
profit equation as:
P(Q) = R(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)]
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
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.
downloading the Excel file?
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