OPTIMAL QUANTITY OF OUTPUT UNDER PERFECT COMPETITION

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OPTIMAL QUANTITY OF OUTPUT (UNDER PERFECT
COMPETITION)

• December 1st, 2009
• Mojca Marc

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OPTIMAL QUANTITY OF OUTPUT
Optimal quantity of output is the one where
profit is maximal (or loss is minimal). Assumption
perfect competition?P is given
Q3
Q4
The company has maximum profit per unit if Q3 is
produced and maxium total profit if Q4 is
produced.
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OPTIMAL QUANTITY OF OUTPUT

• When AC min the company has the maximum profit
  per unit of product, but its total profit is NOT
  maximized at this level of output. The total
  profits still increases if company produces more
  than Q3, because the price (P) for each
  additional product is still higher than the cost
  of each additional product (i.e. marginal cost
  MC) PgtMC.
• The total profit is maximal at that level of
  output, where the cost of an additional product
  (MC) is equal to the price of an additional
  product (P) P MR MC

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Optimal quantity of output at different price
levels
a) PgtAC min
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Optimal quantity of output at different price
levels
b) P AC min
Break-even point and optimal level of output
PMCACmin
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Optimal quantity of output at different price
levels
c) AVCmin lt P lt ACmin
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Optimal quantity of output at different price
levels
d) P AVC min
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Example (Find the correct claim!)

• In short-run, the company will operate despite
  of loss if
• a) the loss is smaller than variable cost
  revenues have to cover at least fixed cost.
• b) the loss is smaller than variable cost
  revenues must cover total cost.
• c) the loss is smaller than fixd cost revenues
  must cover at least variable cost.
• d) the loss is smaller than fixed cost revenues
  must cover total cost.
• e) the loss is smaller than fixed cost revenues
  must cover at least fixed cost.

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Example (Find the correct claim!)

• What is true for a company that operates in a
  perfectly competitive market and produces the
  optimal level of output
• a) If the price is higher than average variable
  cost and lower than average total cost, the
  company has a loss. Because the loss is smaller
  than fixed cost, the company should still operate
  in the short-run, but not in the long-run.
• b) If the price is higher than average variable
  cost and lower than average total cost, the
  company has profit and should continue to
  operate.
• c) If the price is smaller than average variable
  cost, the company has a loss. Because revenues do
  not cover even variable cost, the company should
  stop operating immediately.
• d) If the price is higher than average variable
  cost and lower than average total cost, the
  company has a loss. Because revenues do not cover
  total cost, the company should stop operating
  immediately.
• e) If the price is higher than average total
  cost, the company has profit. Because revenues
  cover total cost, the company should continue to
  operate.

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Optimal quantity of output at different price
levels a) PgtAC min
1. PMC ? Qopt TRQP0QoptAP
2. AC pri Qopt ? Qopt B TCQAC0Qopt BD
P
3. AVC pri Qopt ? Qopt E VCQAVC0Qopt EF
4. AFC pri Qopt ? EB FCQAFCFEBD
TR0QAP, TC0QAPno profit, no loss Break-even
and optimal quantity PMCACmin
P
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c) AVCminltPltACmin

• No break-even point always loss.
• TR0QAP
• TC0QBD
• TCgtTR?losslossPABD
• VC0QEF
• FCFEBD
• LossltFCTRgtVC

P
The company will continue to operate in the
short-run, because it can cover all variable cost
and a part of fixed cost, so the loss is smaller
than fixed cost. If the company stops operating,
the loss is equal to FC!
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d) PAVCmin
No break-even always loss TR0QAP,
VC0QAPTC0QBDTCgtTR?loss lossPABDFCPABD Loss
FCTRVC
P
The critically low level of price, where revenues
just equal variable cost and the loss is equal to
fixed cost is called the shut-down point. At
prices below this point, the company looses more
money if it continues to operate than if it stops
operating. The optimal quantity is at
PMCAVCmin. If PgtAVCmin the company still
operates in the short-run, because it would loose
more money by shutting down.