(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 312

CHAPTER 8 • Profit Maximization and Competitive Supply 287

the firm is also $4 because every bushel of wheat produced will be sold at $4.
Therefore:
The demand curve d facing an individual firm in a competitive market is
both its average revenue curve and its marginal revenue curve. Along this
demand curve, marginal revenue, average revenue, and price are all equal.

Profit Maximization by a Competitive Firm
Because the demand curve facing a competitive firm is horizontal, so that
MR = P, the general rule for profit maximization that applies to any firm can
be simplified. A perfectly competitive firm should choose its output so that
marginal cost equals price:
MC(q) = MR = P
Note that because competitive firms take price as fixed, this is a rule for setting
output, not price.
The choice of the profit-maximizing output by a competitive firm is so important that we will devote most of the rest of this chapter to analyzing it. We begin
with the short-run output decision and then move to the long run.

8.4 Choosing Output in the Short Run
How much output should a firm produce over the short run, when its plant size
is fixed? In this section we show how a firm can use information about revenue
and cost to make a profit-maximizing output decision.

Short-Run Profit Maximization by a Competitive Firm
In the short run, a firm operates with a fixed amount of capital and must choose
the levels of its variable inputs (labor and materials) to maximize profit. Figure 8.3
shows the firm’s short-run decision. The average and marginal revenue curves are
drawn as a horizontal line at a price equal to $40. In this figure, we have drawn
the average total cost curve ATC, the average variable cost curve AVC, and the
marginal cost curve MC so that we can see the firm’s profit more easily.

Profit is maximized at point A, where output is q* ϭ 8 and the price is $40,
because marginal revenue is equal to marginal cost at this point. To see that
q* ϭ 8 is indeed the profit-maximizing output, note that at a lower output, say
q1 ϭ 7, marginal revenue is greater than marginal cost; profit could thus be
increased by increasing output. The shaded area between q1 ϭ 7 and q* shows
the lost profit associated with producing at q1. At a higher output, say q2, marginal cost is greater than marginal revenue; thus, reducing output saves a cost
that exceeds the reduction in revenue. The shaded area between q* and q2 ϭ 9
shows the lost profit associated with producing at q2. When output is q* ϭ 8,
profit is given by the area of rectangle ABCD.
The MR and MC curves cross at an output of q0 as well as q*. At q0, however,
profit is clearly not maximized. An increase in output beyond q0 increases
profit because marginal cost is well below marginal revenue. We can thus

Marginal, average, and total
cost are discussed in §7.1.