Page 627 - Krugmans Economics for AP Text Book_Neat

table 58.1

Short -Run Costs for Jennifer and Jason’s Farm

Quantity of Marginal
tomatoes Marginal cost of revenue Net gain
Q Variable cost Total cost bushel of bushel of bushel=
(bushels) VC TC MC =ΔTC/ΔQ MR MR − MC
0 $0 $14
$16 $18 $2
1 16 30
6 18 12
2 22 36
8 18 10 Section 11 Market Structures: Perfect Competition and Monopoly
3 30 44
12 18 6
4 42 56
16 18 2
5 58 72
20 18 −2
6 78 92
24 18 −6
7 102 116

The sixth and final column shows the calculation of the net gain per bushel of toma-
toes, which is equal to marginal revenue minus marginal cost—or, equivalently in this
case, market price minus marginal cost. As you can see, it is positive for the 1st through
5th bushels; producing each of these bushels raises Jennifer and Jason’s profit. For the
6th bushel, however, net gain is negative: producing it would de-
crease, not increase, profit. So 5 bushels are Jennifer and Jason’s
profit-maximizing output; it is the level of output at which marginal
cost rises from a level below market price to a level above market
price, passing through the market price of $18 along the way.
This example illustrates an application of the optimal output
rule to the particular case of a price-taking firm—the price-taking
firm’s optimal output rule: price equals marginal cost at the price-
taking firm’s optimal quantity of output. That is, a price-taking firm’s
profit is maximized by producing the quantity of output at which Anthony-Masterson/Digital Vision/Getty Images
the market price is equal to the marginal cost of the last unit pro-
duced. Why? Because in the case of a price-taking firm, marginal revenue is
equal to the market price. A price-taking firm cannot influence the
market price by its actions. It always takes the market price as given
because it cannot lower the market price by selling more or raise the market price by
selling less. So, for a price-taking firm, the additional revenue generated by producing
one more unit is always the market price. We will need to keep this fact in mind in fu-
ture modules, in which we will learn that in the three other market structures, firms are
not price takers. Therefore, marginal revenue is not equal to the market price.
Figure 58.1 on the next page shows Jennifer and Jason’s profit-maximizing quantity
of output. The figure shows the marginal cost curve, MC, drawn from the data in the
fourth column of Table 58.1. We plot the marginal cost of increasing output from 1 to
2 bushels halfway between 1 and 2, and likewise for each incremental change. The hor-
izontal line at $18 is Jennifer and Jason’s marginal revenue curve. Remember from
Module 53 that whenever a firm is a price-taker, its marginal revenue curve is a hori-
zontal line at the market price: it can sell as much as it likes at the market price. The price-taking firm’s optimal output
Regardless of whether it sells more or less, the market price is unaffected. In effect, the rule says that a price-taking firm’s profit is
individual firm faces a horizontal, perfectly elastic demand curve for its output—an in- maximized by producing the quantity of
dividual demand curve that is equivalent to its marginal revenue curve. In fact, the hor- output at which the market price is equal to
izontal line with the height of the market price represents the perfectly competitive the marginal cost of the last unit produced.

module 58 Introduction to Perfect Competition 585