Short-run profit maximaation or loss minimization for a perfectly competitive firm Suppose that the market for polo shirts is a perfectly competitive market. The following graph shows the daily cost curves of a firm operating in this market
s In the short run, at a market price of $20 per shirt, this form will choose to produce shirts per day ng the firm’s profit or loss if the market price is $20 and On the previous graph, use the blue rectangle (circle symbols) to shade the area the firm chooses to produce the quantity you already selected. Note: In the following question, you should enter a positive number in the numeri The area of this rectangle indicates that the firm’s per day Proft or LOSS PRICE AND COST (Dollars per shirt)
The Correct Answer and Explanation is :
In a perfectly competitive market, firms aim to maximize profits or minimize losses in the short run by adjusting their output levels. To determine the optimal production quantity and assess profitability, we analyze the firm’s cost curves and the prevailing market price.
Determining the Optimal Output Level:
- Identify the Market Price: In this scenario, the market price is $20 per shirt.
- Locate the Marginal Cost (MC) Curve: The firm’s marginal cost curve represents the additional cost of producing one more unit of output.
- Find the Output Level Where P = MC: In perfect competition, firms produce at the output level where the market price equals marginal cost (P = MC). This ensures that the cost of producing an additional unit is covered by the revenue it generates.
Assessing Profit or Loss:
- Determine Average Total Cost (ATC): The average total cost curve shows the per-unit cost of production at each output level.
- Compare P to ATC at the Optimal Output:
- If P > ATC: The firm is making a profit.
- If P = ATC: The firm is breaking even, earning normal profit.
- If P < ATC: The firm is incurring a loss.
Calculating Profit or Loss:
- Profit or Loss per Unit: The difference between the market price and average total cost at the optimal output level.
- Total Profit or Loss: Profit or loss per unit multiplied by the quantity produced.
Example Calculation:
Suppose the firm produces 100 shirts per day at the optimal output level.
- If P = $20 and ATC = $15:
- Profit per unit = $20 – $15 = $5
- Total profit = $5 × 100 = $500
- If P = $20 and ATC = $25:
- Loss per unit = $20 – $25 = -$5
- Total loss = -$5 × 100 = -$500
Graphical Representation:
On the cost curve graph:
- Optimal Output: The quantity where the MC curve intersects the price line (P = $20).
- Profit or Loss Area: The rectangle formed by the price line, the ATC curve, and the output level.
- Profit: If P > ATC, the rectangle lies above the ATC curve.
- Loss: If P < ATC, the rectangle lies below the ATC curve.
By analyzing the cost curves and the market price, firms can make informed decisions about production levels to achieve profit maximization or loss minimization in the short run.
For a visual explanation, you might find this video helpful:
videoMicro: Unit 3.7 — Graphing Perfectly Competitive Firmsturn0search5