Hi folks, this is chapter 12, part 1.  We're
going to talk about perfect competition,
the first of our market structures, and
specifically how firms choose a profit
maximizing level of output in addition
to learning about q-star.
We're also going to start using our
average total cost curve to understand
profit, loss, and breakeven outcomes for
the firm.  As a small aside, this chapter
is going to build some skills that will
be useful for you for the next three to
four chapters, so make sure that you're
comfortable with this material before
you move on.
Okay so let's jump right into it. 
Firms are trying to maximize profits.
Profits are equal to total revenue minus
the total costs.  Total revenue is nothing
more than P times Q.  We know that
perfectly competitive firms don't have a
choice about price.  They have to sell at
the market price ,and we've already said
that they're going to choose the cost
minimizing solution in production, so
really the only thing they've got to
worry about is how much quantity of
output to produce.  The way that they're
going to decide that is based on our
golden rule.  Once again, they're going to
be looking for a quantity of output that
has the last unit generating a marginal
benefit equal to the cost of producing
it.  So our marginal cost curve (we
developed in Chapter 11) and you'll see
that here, but we have not generated a
marginal benefit though,  which is going
to be essential in order for us to use
our rule.  The marginal benefit curve is
nothing more than the equilibrium price.
So our marginal benefit of selling one
more unit of, let's say blackberrie,  is
equal to the price that we receive for
selling that unit of blackberries....
because we're in a perfectly competitive
market structure we are a tiny tiny tiny
firm. Our production
has no influence over the market
price. We're too small to matter; that's
the assumption were making.  Therefore, what
this firm is trying to decide is the
quantity of blackberries to produce, and
they are weighing what they get out of
selling another unit of blackberries
against the cost of harvesting another
unit of blackberry.  As you can see every
single point to the left of this q*
is going to have a lower marginal cost
then it would have a marginal benefit, so
you could take this Q here and you would
see that it is going to generate a much
smaller cost, let's say two dollars, than
what you'd be able to sell it for, let's say
that our market equilibrium price is
seven dollars.  You're going to want to
make that unit of blackberries, beacause you
sell it for seven and the marginal cost
of acquiring it was only two.  That puts
five extra dollars in your pocket so to
speak.  Of course every single Q all the
way to Q star is going to have a higher
MB. 
You can see that I've outlined it here
in green... than it will have a marginal
cos,t which is what it's going to acquire,
what it could cost you to acquire it. 
You're going to stop when you get to Q
star,  Q star is your optimal point.  If you
choose to produce any Q's to the right
of Q-star we're going to find out that
the marginal benefit is actually going
to be smaller than the marginal cost.  You pick a Q out here, like this one, and we
see that you're still only going to be
able to sell it for seven dollars, but
maybe if you try to harvest that many
blackberries it gets hard to come by
them... that unit might cost you $12 you
only were able to sell it for seven.   So
real simply if MB is bigger than MC keep
making more.  When MB is equal to MC stop,
and never go beyond where MB equals MC,
because you're given your money back away
Alright, let's take a look at how to
actually calculate profit using our
graphs, so I've got a market here.  We'll 
use our Blackberry example again and
let's say that blackberries are
currently selling at $12 per unit....then
we know that our price is going to be
equal to $12.  Our price is also our
marginal benefit; you could also think about
it as marginal revenue,  the extra revenue
generated from selling the next unit of blackberries.
Okay, so first thing I want you to always
do whenever you're working any of these
problems is I want you to find a spot
where marginal revenue equals marginal
cost.   It's gonna be right here.   Once you have
that intersection, just like we were
doing on the last slide, you know your Q
star.  Let's say that this Q star is 700.
We know that our price is $12 and we
know that in order to produce 700 it's gonna
cost us something.  We're going to use the
ATC to figure out how much it's going to
cost us.  Before we get ahead of ourselves,
let's look at the revenue side.  Keep in
mind profit is equal to total revenue
minus total costs.  Total revenue is
nothing more than P times Q.  Our price is
going to be $12.  Each unit of
blackberries sells for $12.  Our quantity
is 700, we know that for Q star.  So we
know then that this height
multiplied by this base will give us the
area of this green box right here.  This
green box is our total revenue.  Now total
revenues are nice, because it's money
coming in, but of course it costs us to
make that output.  We're going to have to
figure out what it costs us, and the way
that we're going to figure it out
is we're going to take an average total
cost multiplied by the quantity that
we're creating.  Our average total cost is
going to be incredibly useful, because
when we take our Q, 
and we actually plug in our Q into our
ATC.  It is going to tell us how much it
cost us to actually produce that
quantity.  So we're going to go straight
up from our 700 until we run into the
ATC, and then we're going to go straight
across and we're going to ask what's our
average total cost when we make 700...
and let's say that the graph tells us it
is $7.  $7 times 700 then 
to give us our total costs.  Total revenue
minus total cost is going to give us our
profit.  Our profits are going to be 5
times 700. We're going to have profit to
$3,500, and graphically it is the
difference between our green box and our
red box, as denoted here.  Our red box is
nothing more than an ATC, which is total
cost divided by quantity, multiplied by
that very same quantity for the base... so
the area of this red rectangle is our
total cost. 
It's going to be smaller than our total
revenues; hence, we know that the
difference between them is our profit,
profit equal to $3,500.
Okay not all firms
are actually going to make profits.
Occasionally the price that is prevailing in
the market is going to generate losses
for that firm.   You have a price that is
lower than their average total cost at
their q*.  Let's take a look at that. 
First things first, find the intersection
between MR and MC... drop down get your
Q star...this is the best output level that's
available for them.  Let's say that it's
400 units.  400 units selling at seven
dollars a pop is going to generate your
total revenue... that green box there.
Height is the price... the width is the
quantity... the area of that green box is
your total revenue.  In order to make that
400 units though its gonna cost you something.
If you plug $400.. 400 units, pardon me.... into the average
total cost...and it will tell you that it
is going to actually cost you $8 on
average for those units.  You got a
problem here, because the height of this
box is 8 and the width is 400,  ATC times Q.
What you end up with is a red box, as
denoted here,  that's bigger than your green
box.
This area that I'm marking in black
here is your loss, and you'd be able to
see that mathematically also if you plugged
in to your equation.  Total revenue is
price times quantity minus total costs,
which we can find by ATC times quantity....
and what we see is that this firm will
be making $400 in
economic losses.
Okay let's do breakeven
next, some firms make profits and  some firms
make losses, but in the long run we
actually expect perfectly competitive
firms to break-even.... reason being is that
if they were actually in a situation
where their price was very very high and
they were generating large profits you
would actually see that lots of firms
jump in.  If they can make good profits
why not.   As they jump in, of course, what
happens is they're going to drive this
price down and they're going to continue
to keep entering as long as the price is
high enough that it's generating profits. 
They're going to stop entering when the
price is actually equal to the ATC... so
when the price reaches the minimum of
the ATC we're going to find out that
this Q star generates a total revenue
box (right P times Q) that is exactly the
same size as the total cost box.... because
when we plug Q into the ATC we see that we
run into the ATC at the exact same time
that we run into the marginal benefit
line.... So total revenue minus total cost
is actually profit.... well if total revenue
is the same size of total cost then
profits are of course equal to zero.  Now
your accountant will tell you that
you're still making a profit,  that's fine. 
They're only paying attention to your
explicit costs.   Economists are going to
insist on actually counting your
implicit costs as well,  your
opportunity cost.
So when we say that you're making zero
economic profits what we really mean is
that you're doing just as well as if you
did your next best option
and this helps economists to tell you
whether or not you need to switch.
It's possible to be making an economic loss
that your accountant would still tell
you is a profit.  What your economist is
trying to describe you is that if you're
making an economic loss.  It means your
next best alternative was actually a
better choice.  In the long run you need
to move and switch where you're putting
your resourcs.
Now you try
I've got a market drawn in nine dollars
is the going rate.  I've got a couple of
numbers over here on the right. I can
give you a situation like this, and I can
ask you to calculate the profit for me...
and I might ask you to graph total
revenue, total cost, and profit.  So go
ahead and pause the video, work through
this, draw out your graph, and calculate
your profit,  and when you're ready hit
play again.
Okay I hope you realized that
we're going to take the market price and
we're going to drag it over and that's
how we got our MB line.  Our price line, it's 
actually our individual firms demand
curve... And it's perfectly elastic, because
they can sell as much as they want at
that price... if they try to raise that
price they lose all of their customers.
Okay,
so price is equal to $9.  Once we figure
out that this is where we have our MB
equals MC intersection,  right our
marginal revenue = marginal cost
intersection... 700 is the best that we can
do.  So we're going to go ahead and we are
going to do P times Q to get our total
revenue box.. and total revenue is going
to be equal to 9 times 700, all right,
total cost are going to be equal to
seven times seven hundred, because when we
plug in our Q star into the ATC is going
to tell us our average total cost, which is
seven dollars.
Seven times seven hundred converts that
average total cost into regular total cost...
and we're going to see that profit then
in equal to two times seven hundred,  or
fourteen hundred dollars... the difference
between the green and the red box as
shown here in blue.
