(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 326

CHAPTER • Profit Maximization and Competitive Supply 301 Dollars per unit of output LMC SMC $40 C D LAC F IGURE 8.13 SAC E A P = MR B G $30 The firm maximizes its profit by choosing the output at which price equals long-run marginal cost LMC In the diagram, the firm increases its profit from ABCD to EFGD by increasing its output in the long run F q1 q2 q3 OUTPUT CHOICE IN THE LONG RUN Output If the firm believes that the market price will remain at $40, it will want to increase the size of its plant to produce at output q3, at which its long-run marginal cost equals the $40 price When this expansion is complete, the profit margin will increase from AB to EF, and total profit will increase from ABCD to EFGD Output q3 is profit-maximizing because at any lower output (say, q2), the marginal revenue from additional production is greater than the marginal cost Expansion is, therefore, desirable But at any output greater than q3, marginal cost is greater than marginal revenue Additional production would therefore reduce profit In summary, the long-run output of a profit-maximizing competitive firm is the point at which long-run marginal cost equals the price Note that the higher the market price, the higher the profit that the firm can earn Correspondingly, as the price of the product falls from $40 to $30, the profit also falls At a price of $30, the firm’s profit-maximizing output is q2, the point of long-run minimum average cost In this case, because P ϭ ATC, the firm earns zero economic profit Long-Run Competitive Equilibrium For an equilibrium to arise in the long run, certain economic conditions must prevail Firms in the market must have no desire to withdraw at the same time that no firms outside the market wish to enter But what is the exact relationship between profitability, entry, and long-run competitive equilibrium? We can see the answer by relating economic profit to the incentive to enter and exit a market ACCOUNTING PROFIT AND ECONOMIC PROFIT As we saw in Chapter 7, it is important to distinguish between accounting profit and economic profit Accounting profit is measured by the difference between the firm’s revenues and its cash flows for labor, raw materials, and interest plus depreciation expenses Economic profit takes into account opportunity costs One such opportunity cost is the return to the firm’s owners if their capital were used elsewhere Suppose,