Study the conditions required for a purely competitive market. These conditions are presented on pp. 593-595.

Look at the graphs at the top of p. 595. The one on the left side has normal looking demand and supply curves and the equilibrium price is $7. The graph on the right side shows that, as a competitor in a perfectly competitive industry, you are a pure price taker at the price of $7. Assume you are a purely competitive corn farmer. You can't raise the price or no one will buy from you. But there is no reason to lower the price because, in this type of market, you can sell any quantity you choose at the going market price of $7. You do not have to reduce your price to sell more. This is because your supply of corn to the market is miniscule compared to the total market supply. You cannot flood the market and drive market price down by bring 50,000 bushels to market as opposed to bringing 10,000 bushels to the marketplace. You also cannot measurably restrict supply and drive up market price by delivering 25,000 bushels instead of 75,000. This is why the demand curve facing the corn farmer is horizontal, or perfectly elastic. In other words, the farmer is a price taker at the market-determined price.

Study the section on profit maximization for a competitive firm. This begins on p. 596.

For profit maximization, use the MR = MC approach for all four market structures. For perfect competition (and perfect competition only), price is equal to marginal revenue (P = MR) since a purely competitive firm does not have to reduce its price in order to sell more. You are looking for the production level at which MR = MC. In some production functions, you may find an exact equality between MR and MC:

Suppose P= MR = 20. Using the MR=MC method, the correct output for profit maximization = 6. Profit would be total revenue (TR) minus total cost (TC). TR = 120 (6 x 20) and so profit = 22 (120 - 98). But since there is an exact equality between MR and MC, we know that for the last unit of production we added the exact same amount to revenue as we did to cost (20). Therefore, the profit at an Output of 5 is also 22. TR would be 100 (5 x 20) minus 78.

Now study the table on p. 600. We notice that P = MR = $35 in the left hand column. The total revenue column (column 9) is simply price times the quantity produced. The profit column (10) is total revenue minus total cost. To determine the profit maximizing level of production, use MR = MC as your primary method. The TR-TC method is secondary.

In this production function, there is not an exact equality between MR and MC. As long as MR exceeds MC, the firm should continue to boost production with this qualification: the firm cannot allow MC to exceed MR at the new, higher quantity produced. Run your left index finger down the left hand column (the MR column). At the same time, look at the MC column (column 7). At a quantity of 8, MR = 35 and MC = 30, so the tendency would be to increase production to 9. But this won't work because at Q = 9, MC = 40 and MR = 35. Profit maximization occurs at Q = 8. Again, MC cannot exceed MR.

Read and study the shutdown point: pp. 603-604.

For the long term, the firm must cover its total costs. Look again at the table on p. 600 and check the average total cost column (ATC). Remember that this is figured on a per unit basis (TC divided by quantity produced). Check the ATC column and find the very lowest entry, which is $24.14. This tells us the lowest price the business firm can accept over the long run. What would TR be at a price of $24.14 and the associated quantity of 7? Answer: $169, which just covers TC of $169. So the lowest acceptable long run price is $24.14.

What is the lowest acceptable price for the short-run?

Note that a firm must pay for its fixed costs even if the firm produces zero output in the short run. (That is, even if the firm produces zero in the short-run, it is not necessarily going out of business.) To find the answer, check the average variable cost (AVC) column and find the lowest entry. It is $17.83 at a quantity of 6. At this price, revenue = $107 ( 6 x $17.83), which just covers the variable cost of $107. True, the firm is stuck with a loss of $40, the fixed cost amount, but it would have this loss even if it produced zero in the short run.

If the firm received a price of, say, $17.88, it could pay the VC and make a small contribution to FC. A firm must be able to pay for its variable costs in order to stay open in the short run.