How much output is produced by the firm over the short period of time, when the size of the plant is fixed? In this part we show how firm uses it information about revenue along with cost in order to make the decision about output in terms of profit maximization.
Short-Run Profit Maximization by a Competitive Firm
To conclude the same in short, a firm will run on a specific principal amount that they will use as capital. It will further help them to choose myriad input levels including labor and material cost. This tab on the data will help to maximize the profit margin. The figure here, (8.3) depicts companies’decision in short run. Here, the average curves and marginal revenue curves of marginal revenue will be drawn horizontally in the same line which has an equal pricing of $40. The same figure also shows Average Total Cost Curve (ATC) with AVC and MC on the same graph of marginal cost.
The maximum amount of profit is considered at point A and the output there is q*. Further the variable values to 8 and monetary evaluation of $40 as MR marginal revenue is same as marginal cost. To establish q* is equal to 8 and is anincome maximizing output, consider a lower output that takes q1 as 7. In a situation where revenue of margin is maximum as compared to thecost of margin, naturally the profit will also increase.
On the other hand, if there is another output q2, where marginal cost is lower than marginal revenue, then the result will have a reduction in output cost and it will directly affect the reduction of revenue cost. The shelteredregionamong q* and q2 is 9, which well defines that the lost amount of profit is has direct production influence on q2. When the output q* is 8; it indicates the profit by rectangle area ABCD.
Marginal revenue and marginal cost curves crossed at an output of qo where profit is not maximized. When there is an increase in the output which is after q0 upsurges profit where marginal cost is lesser than the marginal revenue. One can easily state the conditions for maximization of profit which is as trailsMarginal revenue should be equal to marginal cost at which marginal cost curve is increasing at that point. This part of assumption is very crucialas it will indulge that decision of the companies in the market won which the output of the companies relies in a competition and one can restate it as follows.
The rule of output- If any output is produced by the firm, it should produce to that level where marginal revenue is equivalent of the cost of margin.
Fig 8.3 will also show the profit of competitive in short run. The distance AB is the main difference between the price along with average cost at such output level at q*. Segment BC measures total number of unit which is produced by the firm. Rectangle ABCD is short term firm’s profit.
When the Firm should be Shut Down?
If the firm is in loss of money. What do you think? It should close down or exit from the market? The answer will depend on the part of expectation of the firm in future business conditions. It believes that the conditions of the business will improve in future which will gives profitable part that it makes sense that they should operate at loss for short period of time. Let us assume for an instance that the company will assumes the value of the product which will endureto be as it is for foreseeable future. Then in that case what they do?
It is not the fact that the company is in loss stage in the form of losing money when the price is lower than the average total cost at such output of profit maximization q*. In such instance, if there is any possibility or opportunity that it will enhance then it should switch off and leave the entire industry. This decision is good even if the prices are more than its average variable cost.
If the company endures to manufacture the goods, they will minimize the loss at output q* but they will still run under losses instead of profit as the value is less as compared to the average total cost.
If there is presence of fixed cost average total cost will exceeds the level of variable average cost for the same and the entire cost in average will definitely increase the value so that the company is trailing down capital in this case. The cost which is already fixed does not alter along with the result, but it can be easily removed if the companycloses down or exit from the industry. Fewinstances of fixed cost contain incomes of plant managers along with security personnel and electricity which will keep the light and heat running.
Is shutting down is functional policy? Well, it is not so important. Firm might run at loss in short period of time because they want to gain profit in future period, where there is an increase in the price of the product or if the cost of the production falls. Operation in loss will be more painful, but they will open the best prospects to run better in future period.
However, if someone wants to stay back in the business then any given company will try to retain the flexibility part just to change the total sum of money which is being used. Not only will that it also help in diminishing the average cost. Now, this substitute approach is very interesting. Given, if the price of a product is greater as compared to approx variable cost of production so it will consequently will allow the company to cover a position of fixed costs.