Profits and also Losses through the Average expense Curve

Does maximizing profit (producing wherein MR = MC) imply an actual financial profit? The answer counts on the relationship in between price and average total cost. If the price the a firm charges is greater than that average price of production for that amount produced, then the firm will certainly earn profits. Vice versa, if the price that a certain charges is reduced than that average cost of production, the firm will experience losses. You can think that, in this situation, the farmer might want to shut under immediately. Remember, however, that the certain has currently paid for solved costs, such together equipment, so that may proceed to produce and also incur a loss. Figure 8.5 illustrates three situations: (a) wherein price intersects marginal cost at a level above the average cost curve, (b) where price intersects marginal cost at a level same to the average expense curve, and (c) whereby price intersects marginal cost at a level listed below the average expense curve.

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Figure 8.5. Price and also Average price at the Raspberry farm In (a), price intersects marginal cost above the average price curve. Since price is greater than typical cost, the firm is make a profit. In (b), price intersects marginal cost at the minimum point of the average cost curve. Due to the fact that price is equal to mean cost, the for sure is break even. In (c), price intersects marginal cost below the average expense curve. Because price is much less than typical cost, the certain is do a loss.


First take into consideration a instance where the price is same to $5 for a pack of frozen raspberries. The rule for a profit-maximizing perfect competitive certain is to produce the level that output where Price = grandfather = MC, so the raspberry farmer will create a amount of 90, which is labeled together E in number 8.5 (a). Remember the the area the a rectangle is equal to its base multiplied by its height. The farm’s complete revenue in ~ this price will be presented by the larger rectangle starting from the origin right to a amount of 90 packs (the base) increase to suggest E (the height), left come the price that $5, and back down come the origin. The average cost of creating 90 packs is displayed by suggest C or around $3.50. Complete costs will certainly be the amount of 90 times the average cost of $3.50, which is shown by the area the the rectangle indigenous the beginning to a amount of 90, increase to suggest C, over to the vertical axis and down come the origin. It have to be clean from evaluating the two rectangles that full revenue is higher than total cost. Thus, earnings will it is in the blue shaded rectangle on top.

It have the right to be calculation as:

profit=total revenue − total cost
=(90)($5.00) − (90)($3.50)
=$135

Or, it can be calculate as:

profit=(price − median cost) × quantity
=($5.00 − $3.50) × 90
=135

Now consider Figure 8.5 (b), whereby the price has actually fallen come $3.00 because that a fill of frozen raspberries. Again, the perfectly competitive firm will choose the level of output whereby Price = grandfather = MC, yet in this case, the quantity created will it is in 70. At this price and output level, whereby the marginal cost curve is cross the average price curve, the price obtained by the for sure is specifically equal come its average price of production.

The farm’s complete revenue in ~ this price will be shown by the large rectangle indigenous the origin over to a quantity of 70 packs (the base) up to allude E’ (the height), over to the price of $3, and ago to the origin. The average price of creating 70 package is the same as the farm’s full revenue since the price of one unit is equal to the expense to create that unit. Thus, the firm is make zero profit. The calculations space as follows:

profit=total revenue − full cost
=(70)($3.00) − (70)($3.00)
=$0

Or, it can be calculate as:

profit=(price − typical cost) × quantity
=($3.00 − $3.00) × 70
=$0

In figure 8.5 (c), the sector price has actually fallen still additional to $2.00 for a pack of frozen raspberries. At this price, marginal revenue intersects marginal cost at a amount of 50. The farm’s complete revenue at this price will be displayed by the rectangle native the origin over to a amount of 50 packs (the base) up to allude E” (the height), end to the price the $2, and earlier to the origin. The average cost of developing 50 package is presented by point C” or about $3.30. Full costs will be the amount of 50 times the average price of $3.30, which is shown by the area the the rectangle native the origin to a amount of 50, up to suggest C”, over to the upright axis and also down come the origin. It must be clean from analyzing the two rectangles that complete revenue is less than total cost. Thus, the for sure is losing money and the loss (or negative profit) will certainly be the rose-shaded rectangle.

The calculations are:

profit=total revenue − total cost
=(50)($2.00) − (50)($3.30)
=-$65.00

Or:

profit=(price − average cost) × quantity
=($1.75 − $3.30) × 50
=-$65.00

If the market price obtained by a perfect competitive firm leads it to produce at a quantity where the price is better than median cost, the firm will earn profits. If the price got by the firm causes it to create at a quantity where price equates to average cost, which occurs at the minimum suggest of the AC curve, then the for sure earns zero profits. Finally, if the price got by the firm leads it to create at a amount where the price is much less than average cost, the firm will certainly earn losses. This is summarized in Table 8.4.

Table 8.4If…Then…
Price > ATCFirm earns an economic profit
Price = ATCFirm earns zero economic profit
Price

Watch this video to check out the principle of economic profit explained:

Self Check: Profit and also Losses in vain Markets

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