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By the end of this section, you will be able to:
  • Calculate profits by comparing total revenue and total cost
  • Identify profits and losses with the average cost curve
  • Explain the shutdown point
  • Determine the price at which a firm should continue producing in the short run

A perfectly competitive firm has only one major decision to make—namely, what quantity to produce. To understand why this is so, consider a different way of writing out the basic definition of profit :

Profit = Total revenue Total cost           = ( Price ) ( Quantity produced ) ( Average cost ) ( Quantity produced )

Since a perfectly competitive firm must accept the price for its output as determined by the product’s market demand and supply, it cannot choose the price it charges. This is already determined in the profit equation, and so the perfectly competitive firm can sell any number of units at exactly the same price. It implies that the firm faces a perfectly elastic demand curve for its product: buyers are willing to buy any number of units of output from the firm at the market price. When the perfectly competitive firm chooses what quantity to produce, then this quantity—along with the prices prevailing in the market for output and inputs—will determine the firm’s total revenue, total costs, and ultimately, level of profits.

Determining the highest profit by comparing total revenue and total cost

A perfectly competitive firm can sell as large a quantity as it wishes, as long as it accepts the prevailing market price. Total revenue is going to increase as the firm sells more, depending on the price of the product and the number of units sold. If you increase the number of units sold at a given price, then total revenue will increase. If the price of the product increases for every unit sold, then total revenue also increases. As an example of how a perfectly competitive firm decides what quantity to produce, consider the case of a small farmer who produces raspberries and sells them frozen for $4 per pack. Sales of one pack of raspberries will bring in $4, two packs will be $8, three packs will be $12, and so on. If, for example, the price of frozen raspberries doubles to $8 per pack, then sales of one pack of raspberries will be $8, two packs will be $16, three packs will be $24, and so on.

Total revenue and total costs for the raspberry farm, broken down into fixed and variable costs, are shown in [link] and also appear in [link] . The horizontal axis shows the quantity of frozen raspberries produced in packs; the vertical axis shows both total revenue and total costs, measured in dollars. The total cost curve intersects with the vertical axis at a value that shows the level of fixed costs, and then slopes upward. All these cost curves follow the same characteristics as the curves covered in the Cost and Industry Structure chapter.

Total cost and total revenue at the raspberry farm

The graph shows that firms will incur a loss if the total cost is higher than the total revenue.
Total revenue for a perfectly competitive firm is a straight line sloping up. The slope is equal to the price of the good. Total cost also slopes up, but with some curvature. At higher levels of output, total cost begins to slope upward more steeply because of diminishing marginal returns. The maximum profit will occur at the quantity where the gap of total revenue over total cost is largest.

Questions & Answers

what is Debenture in economy
Gideon Reply
what is economic
Vida Reply
Economic is a seines which study the human behavior as ends and scarce means which have alternative uses
Debrah
Economics is the study of how human make decisions in the face of scarcity. These can be individual decisions, family decisions, business decisions or societal decisions.
Wandji
Economics is a science that study human behaviour as a relationship between ends and scarce means which may have alternative uses.
Elizabeth
in my opinion, economics helps us to learn decision making not only in short term but in long term too
shubham
what is special directives
Emmanuel Reply
what is demand
Joseph Reply
Demand simply refers to the amount of goods and services which the consumer is willing and able to purchase at each price
Owusu
Demand refers to the quantity of goods and services an individial is willing and able to purchase or buy at various price over a period of time
Elizabeth
what is mean by unitary elastic demand
Bangniyel Reply
demand is said to be unitary elastic when the percentage change in the demand is equal to the percentage change in the price
George
what is the principle of equi-marginal utility
Reliance Reply
what is Economics and it important
Anita Reply
what is production
Anita
what is Economic
Anita Reply
what is the meaning of Economic
Anita
economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses
Boso
I don't know.
natchanan
u don't
Ssali
@ Boso thanks for the definition ✌
Raewyn
boso u r too much u try
Liambee
ya nyc
Ssali
Thanks kk
Anita
pls can I ask more questions
Anita
what is production
Anita
production is creation of goods and services
George
what is macroeconomics and microeconomics
Anita
macroeconomics deals with larger economic units such as GDP,GNP,employment while microeconomics deals with smaller economic units such firm and household
George
Thanks
Anita
Explain the ff Scarcity Ends Demand Supply Choice Scale of preference
Anita
macroeconomics deals with larger economic units such as GDP,GNP,employment while microeconomics deals with smaller economic units such firm and household
George
Gross Domestic product...it represent the total value of the products produced within the country including foreign industries
George Reply
what is products
Anita
what are the favourable demand
Odia Reply
list of climate that affect demands
Odia
What is two major forms of international trade?
Musa Reply
What is Economics and why it is important
Abdul Reply
De ans,Economics is the study of women behavior as a relationship between end and scared mean which have alternative uses.
Anita
What is Inflation
Abdul Reply
More money = more consumers, more consumers = lessen the product, less product = high price, high price = inflation
TuroN
is it definition
Odia
why price and quantity increase
Otuu Reply
condition under which price and quantity will be increased at the same time
Otuu
factors that hinders mobility of labour
Dennis Reply

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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