Calculating economic profit and the profit-per-unit fallacy

154 Part III: Market Structures and the Decision-Making Environment

Assume the market-determined price for your good is $4.80. Therefore, your total revenue equals

Marginal revenue equals the derivative of total revenue taken with respect to quantity, or

If your total cost function is

Marginal cost equals

Again, to determine the profit-maximizing quantity of output, set marginal revenue or price equal to marginal cost.

1. Set marginal revenue equal to marginal cost.

2. Solve for q by using the quadratic formula.

The profit-maximizing quantity of output is 800 units.

3. Determine the average-total-cost equation.

Average total cost equals total cost divided by the quantity of output.

Chapter 9: Limited Decision-Making in Perfect Competition

4. Substitute the profit-maximizing quantity of 800 for q to determine average total cost.

5. Calculate profit per unit.

155

or profit per unit equals –$7.83125.

6. Determine total profit by multiplying profit per unit by the profitmaximizing quantity of output.

or total profit equals –$6,265. By producing 800 units of output where marginal revenue equals marginal cost, your firm is losing $6,265. But note that if you immediately shut down, your losses equal total fixed cost, which is only $5,625. Losing $5,625 is a bad situation, but losing $6,265 is even worse. Shutting down immediately becomes your best option for minimizing your losses.

Disappearing Profit in the Long Run

The long run is a period of time in which all inputs you employ are variable. Therefore, the perfectly competitive firm operating in the long run can change the quantity employed of any input — fixed inputs don’t exist.

Perfect competition has two important characteristics that influence the long-run equilibrium: easy entry and exit and the firm is a price taker.

✓ Easy entry and exit: Firms have no difficulty moving into or out of a perfectly competitive market. ✓ Price taker: Individual firms can’t set price, but they can sell everything they produce at the price established by the market.