5 Steps to a 5 AP Microeconomics, 2014-2015 Edition

118 › Step 4. Review the Knowledge You Need to Score High

horizontal. If the market price of barley falls, quantity demanded rises. Figure 9.1 illustrates

the difference between market demand (D) and the demand for one firm’s product (d).

Profit Maximization

Let’s get one thing straight. When we say firms maximizeeconomic profit, this means they

are not going to settle for anything less than the highest possible difference between total rev-

enue and total economic cost. If an additional dollar of profit is to be earned, they take that

opportunity. If the maximum profit possible is actually zero, or even negative dollars, they

accept this short-run outcome. There are two equivalent ways to maximize economic profit.

The Method of “Totals’’

The perfectly competitive firm cannot change the price; it can only adjust output. To maximize

profit, the firm selects the output to maximize:

Economic profit (p) =Total revenue -Total economic cost

An example should help to illustrate how a firm goes about maximizing profit.

Example:

A carrot farmer operates in a perfectly competitive market. The going price for a

bushel of carrots is $11. Table 9.1 summarizes how total revenue, total cost, and

profit differ at various levels of output. Because it is the short run, there exist $16

of fixed costs. All costs reflect the explicit and implicit costs of hiring a resource.

Table 9.1

DAILY BUSHELS OF TOTAL TOTAL PROFIT

CARROTS (q) PRICE (P) REVENUE (TR) COST (TC) (P)

0 $11 $0 $16 -$16

1 $11 $11 $22 -$11

2 $11 $22 $27.50 -$5.50

3 $11 $33 $34 -$1

4 $11 $44 $42 $2

5 $11 $55 $53 $2

6 $11 $66 $65 $1

Because the firm is a price taker, the level of output does not affect the going price. Total

costs rise as production increases, a concept seen in the previous chapter. As a profit maximizer,

our carrot farmer would choose to produce five bushels per day and earn $2 in daily economic

profit. Note, when there are two quantities that produce the same amount of profit, like four

and five bushels, we select the larger of the two quantities. This method of profit maximization

is much like trial and error and is a bit cumbersome. Let’s explore an equivalent and easier way.

The Method of “Marginals”

Throughout this book we have seen illustrations of marginal analysis, and this situation is

no different. You’ll recall that rational decision making implies the following:

•If MB >MC, do more of it.

•If MB <MC, do less of it.

•If MB =MC, stop here.

KEY IDEA

TIP

http://www.ebook3000.com