Graphing Exercise: Short-Run Profit Maximization

A competitive firm is a price-taker, able to produce and sell as little or as much as it desires at the going market price. In other words, demand for a competitive firm is perfectly elastic at the market price. Since firms are assumed to maximize profit, the firm’s only choice is how much output, if any, to produce to achieve maximum profit.

Exploration: What output level will a competitive firm choose to obtain maximum profit?


The graph shows the average- and marginal-cost curves of a typical competitive firm. Initially, market price is $80 and the firm is producing 80 units per week. Its fixed costs are $2700 per week. To use the graph, click and drag the blue triangle on the vertical axis to change the market price, hence the firm’s demand curve. Click and drag the blue triangle on the horizontal axis to change the firm’s choice of output. Cost and profit data are shown in the box at right; clicking on the Show Profit/Loss button will provide a graphical illustration of the firm’s profit or loss: profit in green; losses in red. Clicking the Reset button will restore all initial values.

  1. At the initial market price of $80 and output level of 80 units per week, how much profit is the firm earning? Will any other output choice provide a higher profit at this price?
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  2. Holding price constant at $80, use the slider to view several different output levels, comparing price and marginal cost at each one. If marginal cost is below the price at a particular output level, how should the firm adjust its output to increase its profits? How should the firm adjust its output if its marginal cost exceeds the price?
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  3. Suppose the market price rises from $80 to $100. Should the firm continue to produce 80 units? At its profit-maximizing output level, will the firm’s profits be higher, lower, or the same as before?
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  4. If price suddenly falls to $60 per week, should the firm shut down?
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  5. Experiment on your own. What is the rule for profit maximization?
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