[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Figure 7.3 develops the graphical analysis underlying this principle. Panel A
shows the firm’s marginal cost curve. If the price of the good in a competitive market
is p 1 , the profit-maximizing output level will be Q 1 . This is the level of output at which
price and marginal cost are equal. An upward-sloping marginal cost curve clearly
leads the firm to produce more as price increases.
The marginal cost curve is upward sloping, just as the supply curves in Chapter 3
were upward sloping. This too is no accident: a firm’s marginal cost curve is actually
the same as its supply curve. The marginal cost curve shows the additional cost of
producing one more unit at different levels of output. A competitive firm chooses
to produce at the level of output where the cost of producing an additional unit (that
is, the marginal cost) is equal to the market price. We can thus read from the marginal
cost curve what the firm’s supply will be at any price: it will be the quantity of
output at which marginal cost equals that price.
Before we turn to Figure 7.3B, look once more at Figure 7.2A, which shows total
revenues as well as total costs of the High Strung Violin Company. We can see that
profits—the gap between revenues and costs—are maximized at an output of either 7
or 8. If the price were just slightly lower than $40,000, profits would be maximized at
7, and if the price were just slightly higher than $40,000, profits would be maximized
at 8.
The profit-maximizing level of output can also be seen in panel B of Figure 7.3,
which shows the total revenue and total cost curves. Profits are the difference
between revenues and costs. In panel B, profits are the distance between the total
revenue curve and the total cost curve. The profit-maximizing firm will choose the
A
B
COST OR PRICE (DOLLARS PER UNIT)
Marginal
cost curve
COST OR REVENUE ($)
Slope of the
total revenue
curve = price
p 1
Q 1
QUANTITY (Q )
Total cost
curve
Profits
Total
revenue
curve
Slope of the
total cost
curve =
marginal cost
QUANTITY (Q )
Figure 7.3
THE PROFIT-MAXIMIZING LEVEL
OF OUTPUT
A competitive firm maximizes profits by setting output at the point where price equals marginal
cost. In panel A, at the price of p 1 , this quantity is Q 1 . Panel B shows total revenue and
total costs. Profits are maximized when the distance between the two curves is maximized,
which is the point where the two lines are parallel (and thus have the same slope).
Q 1
BASIC CONDITIONS OF COMPETITIVE SUPPLY ∂ 159