# 8.2 How perfectly competitive firms make output decisions  (Page 10/28)

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Q P TFC TVC TC AVC ATC MC TR Profits
0 \$28 \$20 \$0 \$20 - - - \$0 −\$20
1 \$28 \$20 \$20 \$40 \$20.00 \$40.00 \$20 \$28 −\$12
2 \$28 \$20 \$25 \$45 \$12.50 \$22.50 \$5 \$56 \$11
3 \$28 \$20 \$35 \$55 \$11.67 \$18.33 \$10 \$84 \$29
4 \$28 \$20 \$52 \$72 \$13.00 \$18.00 \$17 \$112 \$40
5 \$28 \$20 \$80 \$100 \$16.40 \$20.40 \$30 \$140 \$40

Step 5. Once you have determined the profit-maximizing output level (in this case, output quantity 5), you can look at the amount of profits made (in this case, \$40).

Step 6. If the firm is making economic losses, the firm needs to determine whether it produces the output level where price equals marginal revenue and equals marginal cost or it shuts down and only incurs its fixed costs.

Step 7. For the output level where marginal revenue is equal to marginal cost, check if the market price is greater than the average variable cost of producing that output level.

• If P>AVC but P<ATC, then the firm continues to produce in the short-run, making economic losses.
• If P<AVC, then the firm stops producing and only incurs its fixed costs.

In this example, the price of \$28 is greater than the AVC (\$16.40) of producing 5 units of output, so the firm continues producing.

## Key concepts and summary

As a perfectly competitive firm produces a greater quantity of output, its total revenue steadily increases at a constant rate determined by the given market price. Profits will be highest (or losses will be smallest) at the quantity of output where total revenues exceed total costs by the greatest amount (or where total revenues fall short of total costs by the smallest amount). Alternatively, profits will be highest where marginal revenue, which is price for a perfectly competitive firm, is equal to marginal cost. If the market price faced by a perfectly competitive firm is above average cost at the profit-maximizing quantity of output, then the firm is making profits. If the market price is below average cost at the profit-maximizing quantity of output, then the firm is making losses.

If the market price is equal to average cost at the profit-maximizing level of output, then the firm is making zero profits. The point where the marginal cost curve crosses the average cost curve, at the minimum of the average cost curve, is called the “zero profit point.” If the market price faced by a perfectly competitive firm is below average variable cost at the profit-maximizing quantity of output, then the firm should shut down operations immediately. If the market price faced by a perfectly competitive firm is above average variable cost, but below average cost, then the firm should continue producing in the short run, but exit in the long run. The point where the marginal cost curve crosses the average variable cost curve is called the shutdown point.

## Problems

The AAA Aquarium Co. sells aquariums for \$20 each. Fixed costs of production are \$20. The total variable costs are \$20 for one aquarium, \$25 for two units, \$35 for the three units, \$50 for four units, and \$80 for five units. In the form of a table, calculate total revenue, marginal revenue, total cost, and marginal cost for each output level (one to five units). What is the profit-maximizing quantity of output? On one diagram, sketch the total revenue and total cost curves. On another diagram, sketch the marginal revenue and marginal cost curves.

Perfectly competitive firm Doggies Paradise Inc. sells winter coats for dogs. Dog coats sell for \$72 each. The fixed costs of production are \$100. The total variable costs are \$64 for one unit, \$84 for two units, \$114 for three units, \$184 for four units, and \$270 for five units. In the form of a table, calculate total revenue, marginal revenue, total cost and marginal cost for each output level (one to five units). On one diagram, sketch the total revenue and total cost curves. On another diagram, sketch the marginal revenue and marginal cost curves. What is the profit maximizing quantity?

A computer company produces affordable, easy-to-use home computer systems and has fixed costs of \$250. The marginal cost of producing computers is \$700 for the first computer, \$250 for the second, \$300 for the third, \$350 for the fourth, \$400 for the fifth, \$450 for the sixth, and \$500 for the seventh.

1. Create a table that shows the company’s output, total cost, marginal cost, average cost, variable cost, and average variable cost.
2. At what price is the zero-profit point? At what price is the shutdown point?
3. If the company sells the computers for \$500, is it making a profit or a loss? How big is the profit or loss? Sketch a graph with AC, MC, and AVC curves to illustrate your answer and show the profit or loss.
4. If the firm sells the computers for \$300, is it making a profit or a loss? How big is the profit or loss? Sketch a graph with AC, MC, and AVC curves to illustrate your answer and show the profit or loss.

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