AP_Krugman_Textbook

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 Eis 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 profitis 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.

So we will assume, as usual, that the cost numbers given in Table 58.1 in-

clude all costs, implicit as well as explicit. What determines whether Jennifer

586 section 11 Market Structures: Perfect Competition and Monopoly

figure 58.1

The Price-Taking Firm’s Profit-

Maximizing Quantity of Output

At the profit-maximizing quantity of output, the

market price is equal to marginal cost. It is lo-

cated at the point where the marginal cost

curve crosses the marginal revenue curve,

which is a horizontal line at the market price

and represents the firm’s demand curve. Here,

the profit-maximizing point is at an output of

5 bushels of tomatoes, the output quantity at

point E.

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$24

20

18

16

12

8

6

Price, cost

of bushel

Quantity of

tomatoes

(bushels)

MC

MR = P = D

E

Profit-maximizing

quantity

Optimal

point

Market

price

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