Page 628 - Krugmans Economics for AP Text Book_Neat

figure 58.1

The Price-Taking Firm’s Profit- Price, cost
of bushel
Maximizing Quantity of Output
At the profit-maximizing quantity of output, the
market price is equal to marginal cost. It is lo- $24 Optimal MC
cated at the point where the marginal cost point
curve crosses the marginal revenue curve, 20 E
which is a horizontal line at the market price Market 18 MR = P = D
price
and represents the firm’s demand curve. Here, 16
the profit-maximizing point is at an output of
5 bushels of tomatoes, the output quantity at 12
point E.
8
6

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

firm’s demand, marginal revenue, and average revenue—the average amount of revenue
taken in per unit—because price equals average revenue whenever every unit is sold for
the same price. The marginal cost curve crosses the marginal revenue curve at point E.
Sure enough, the quantity of output at E is 5 bushels.
Does this mean that the price-taking firm’s production decision can be entirely
summed up as “produce up to the point where the marginal cost of production is
equal to the price”? No, not quite. Before applying the principle of marginal analysis
to determine how much to produce, a potential producer must as a first step answer
an “either–or” question: should it produce at all? If the answer to that question is yes,
it then proceeds to the second step—a “how much” decision: maximizing profit by
choosing the quantity of output at which marginal cost is equal to price.
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. In the next module we’ll see that unprofitable firms shut down in the
long run, but tolerate losses in the short run up to a certain point.

When Is Production Profitable?
Remember from Module 52 that firms make their production decisions with the goal of
maximizing economic profit—a measure based on the opportunity cost of resources used by
the firm. 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 con-
trast, accounting profit is profit calculated using only the explicit costs incurred
by the firm. This means that economic profit incorporates all of the opportu-
nity cost of resources owned by the firm and used in the production of output,
while accounting profit does not. A firm may make positive accounting profit
while making zero or even negative economic profit. It’s important to under-
stand that a firm’s decisions of how much to produce, and whether or not to
stay in business, should be based on economic profit, not accounting profit.
iStockphoto clude all costs, implicit as well as explicit. What determines whether Jennifer
So we will assume, as usual, that the cost numbers given in Table 58.1 in-

586 section 11 Market Structures: Perfect Competition and Monopoly