Page 581 - Krugmans Economics for AP Text Book_Neat

figure 53.1

The Firm’s Profit- Price, cost
of bushel
Maximizing Quantity
of Output
Optimal MC
At the profit-maximizing quantity of output, $24 point
marginal revenue is equal to marginal cost.
It is located at the point where the marginal 20 E
Market
cost curve crosses the marginal revenue 18 MR = P
price
curve, which is a horizontal line at the mar- 16
ket price. Here, the profit-maximizing point Section 10 Behind the Supply Curve: Profit, Production, and Costs
is at an output of 5 bushels of tomatoes, the 12
output quantity at point E.
8
6

0 1 2 3 4 5 6 7
Quantity of
Profit-maximizing tomatoes
quantity (bushels)

To understand why the first step in the production decision involves an “either–or”
question, we need to ask how we determine whether it is profitable or unprofitable to
produce at all.

When Is Production Profitable?
Recall that a firm’s decision whether or not to stay in a given business depends on its
economic profit—a measure based on the opportunity cost of resources used in the busi-
ness. To put it a slightly different way: in the calculation of economic profit, a firm’s
total cost incorporates the implicit cost—the benefits forgone in the next best use of
the firm’s resources—as well as the explicit cost in the form of actual cash outlays. In
contrast, accounting profit is profit calculated using only the explicit costs incurred by
the firm. This means that economic profit incorporates the opportunity cost of re-
sources owned by the firm and used in the production of output, while accounting
profit does not. As in the example of Babette’s Cajun Café, a firm may make positive ac-
counting profit while making zero or even negative economic profit. It’s important to
understand clearly that a firm’s decision to produce or not, to stay in business or
to close down permanently, should be based on economic profit, not account-
ing profit.
So we will assume, as we always do, that the cost
numbers given in Tables 53.1 and 53.2 include all
costs, implicit as well as explicit, and that the profit
numbers in Table 53.1 are economic profit. What de-
termines whether Jennifer and Jason’s farm earns a
profit or generates a loss? The answer is that whether
or not it is profitable depends on the market price of
tomatoes—specifically, whether selling the firm’s optimal quantity
of output at the market price results in at least a normal profit.
In the next modules, we look in detail at the two compo- Photodisc
nents used to calculate profit; firm revenue (which is deter-
mined by the level of production) and firm cost.

module 53 Profit Maximization 539