Profit Maximization in the Short Run In a purely competitive firm, it can only maximize its economic profit or minimize

its loss only by adjusting its output. There are two ways in which the firm can determine its level of output to achieve its maximum profit. First is the Total Revenue Total Cost Approach and the Marginal Revenue Marginal Cost Approach. Total Revenue Total Cost Approach Total Output 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Total Revenue 0 131 262 393 524 655 786 917 1048 1179 1310 1441 1572 1703 1834 1965 Total Cost 100 190 270 340 400 470 550 640 750 880 1030 1200 1390 1590 1810 2050 Profit or Loss -100 -59 -8 53 124 185 236 277 298 299 280 241 182 113 24 -85

2500
Break-even point (normal profit)

2000

1500

Maximum economic profit $299

Total Revenue Total Cost

1000

500
Break-even point (normal profit)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Based on the table and figure above, using the total revenue total cost approach, the ideal level of output should be 9 units. This is where the total revenue exceeds its total cost at maximum. In the graph, total revenue and total costs are equal where the two curves intersect. Total revenue covers all costs, but there is no economic profit. This is the break-even point: an output at which a firm makes a normal profit but not an economic profit. Marginal Revenue Marginal Cost Approach In this approach, the firm compares amounts that each additional unit of output would add to total revenue and to total cost. In other words, the firm compares the marginal revenue (MR) and the marginal cost (MC) MR = MC Rule In the short-run , the firm will maximize profit or minimizes loss by producing the output t which marginal revenue equals marginal cost. Three Characteristics of the MR = MC Rule The rule applies only if producing is preferable to shutting down. This happens when marginal revenue does not equal or exceed average variable cost, the firm will shut down rather than produce the MR = MC output. The rule is an accurate guide to profit maximization for all firms whether they are purely competitive, monopolistic, monopolistically competitive, or oligopolistic. The rule can be restated as P=MC when applied to a purely competitive firm. When producing is preferable to shutting down, the competitive firm that wants to maximize its profit or minimize its loss should produce at that point where price equals marginal cost.

Profit Maximization Case

200 180 160 140 120 100 80 60 40 20 0 1 2 3 4 5 6 7 8 9 10
Economic Profit

AVC ATC MC MR

The MR = MC output enables the purely competitive firm to maximize profits or to minimize losses. In this case MR (=P in pure competition) and MC are equal to an output of 9 units. There P exceeds the average total cost A 97.78, so the firm realizes an economic profit of P-A per unit. The economic profit is presented by the blue rectangle and is 9 x (P-A).

Loss Minimizing Case

200 180 160 140 120 100 80 60 40 20 0 1 2 3 4 5 6 7 8 9 10
Loss

AVC ATC MC MR

If price P exceeds the minimum AVC but is less than ATC, the MR = MC output will permit the firm to minimize its losses. In this instance the loss is A P per unit, where A is the average total cost at 6 units of output. The total loss is shown by the white area and is equal to 6 x (A P) Shutdown Case
200 180 160 140 120 100 80 60 40 20 0 1 2 3 4 5 6 7 8 9 10 AVC ATC MC MR

If price P falls below the minimum AVC the competitive firm will minimize its losses in the short run by shutting down. There is no level of output at which the firm can produce and realize a loss smaller than its total fixed cost.