The short-run profitability of a competitive firm

A competitive firm making positive profit.

 

The average and marginal revenue curves are drawn as a horizontal lines at a price equal to $ 40. In the short run the competitive firm maximizes its profit by choosing the output q* = 8, corresponding to point A at which its MC = P or MR. The profit of the firm is measured by the rectangle ABCD. Any lower output such as q₁ or higher output as q₂, will lead to lower profits. For example at a lower output q₁ = 7 MR revenue is greater the MC, so profit could be increased by increasing output. The shaded area between q₁ = 7 and q* shows the lost profit associated with producing q₁

At a high output q₂ MC is greater than MR. Therefore reducing output saves a cost that exceeds the reduction in output. The shaded area between q* and q₂ = 9 shows the lost profit associated with producing at q₂. The MR and MC curves cross at an output of q₀ as well as q* At q₀ the profit is not maximized. An increase in output beyond q₀ increases profit because MC is below MR. Thus the condition for profit maximization is that MC equals to MR at a point at which the MC curve is rising rather than falling. Note that the segment BC measures the total number of units produced. The distance AB is the difference between price and average cost at the output level q*, which is average profit per unit of output.

Per unit profit = (P - AC) / (P - C)

Total profit = P - AC(Q).

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