# Maximizing Profit under Competition

… a core concept in Economic Analysis and Atlas102

### Concept description

Alex Tabarrok (reference below, video on right) describes the key characteristics of a firm operating under conditions of Perfect Competition.

###### Competitive firm

Tabarrok summarized the characteristics of a firm operating under conditions of perfect competition: ###### Choosing the price to sell the output

Tabarrok uses the example of an owner of small stripper well to illustrate the two key features of a firm operating in a perfectly competitive market:

• The firm has no control over price – demand for the product is perfectly elastic (quantity produced will not affect market price)
• The firm’s only choice is over the quantity to produce and sell ###### What is profit?

In his next video (right), Tabarrok reviews the requirements for making a profit.

Total Revenue = Price x Quantity (P x Q)

Total Cost (TC) = Fixed Costs + Variable Costs

###### Costs include opportunity costs

Costs measured by economists differ from those measured by accountants. Economic analysis includes Opportunity Cost (such as foregone interest for the capital invested in the business).

###### Choosing the level of output to maximize profit

Marginal Revenue (MR) = the addition to total revenue from selling and additional unit of output

Marginal Cost (MC) = the addition to total cost from producing and additional unit of output

Profits are maximized at the level of output where MR = MC ###### What is the size of the profit?

In his next video (right) Tabarrok explains how to use the average cost curve to calculate the size of profit (and whether it is positive or actually a loss) and to show it on a graph. The average cost is the total cost, TC, divided by the quantity produced, Q.

Average Cost (AC) = the cost per unit of output = TC/Q

This can be rearranged to read:

Profit = (P – AC) x Q

and this can be viewed on a graph as follows: Note that maximizing profit does not mean that profit is positive. If the price is below the Break-even Price, the firm will be operating at a loss, which will be the rational course of action when the price for the product is above the marginal cost of producing it and fixed costs are truly fixed. See also Entry, Exit, and Sunk Costs. ###### Practice questions

From http://www.mruniversity.com/node/230468, and http://www.mruniversity.com/node/230512, and http://www.mruniversity.com/node/264181, accessed 3 May 2016.

1. A competitive firm maximizes profit by choosing
1. B

Atlas topic, subject, and course

Producer Theory and Competition (core topic) in Economic Analysis and Atlas102 Economic Analysis.

###### Source

Alex Tabarrok, Introduction to the Competitive Firm (7-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/deeper-look-tradeable-allowances, accessed 6 May 2016.

Alex Tabarrok, Maximizing Profit under Competition (13-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/deeper-look-tradeable-allowances, accessed 6 May 2016.

Alex Tabarrok, Maximizing Profit and the Average Cost Curve (12-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/profit-maximization-average-cost, accessed 6 May 2016.