One of Three Alternatives

• With profit maximization, price exceeds average total cost at the quantity that equates marginal revenue and marginal cost. In this case, the firm generates an economic profit.


• With loss minimization, price exceeds average variable cost but is less than average total cost at the quantity that equates marginal revenue and marginal cost. In this case, the firm incurs a smaller loss by producing some output than by not producing any output.

Amblathan-Plus Production

Profit and Loss

The three U-shaped cost curves used in this analysis provide all of the information needed on the cost side of the firm's decision. The demand curve facing the firm (which is also the firm's average revenue curves) and the corresponding marginal revenue curve provide all of the information needed on the revenue side.

For the time being, Feet-First Pharmaceutical maximizes profit by producing 6 ounces of Amblathan-Plus and charges a price of $7.50. This profit-maximizing situation depends on the existing market demand conditions. However, should this demand change, then maximizing a positive profit is not the primary concern of Feet-First Pharmaceutical. Its decision turns to minimizing loss. Click the [Less Demand] button to illustrate the situation facing Feet-First Pharmaceutical with a decrease in demand.

As the demand shifts leftward, the marginal revenue curve also shifts leftward. The new profit-maximizing intersection between marginal cost and marginal revenue is at 2 ounces of Amblathan-Plus. The price Feet-First Pharmaceutical charges for this quantity of production is then $5.50.

The key is that this new, lower price is less than average variable cost. This means that Feet-First Pharmaceutical does not generate enough revenue per ounce of Amblathan-Plus sold (average revenue = $5.50) to cover the variable cost of producing each ounce of Amblathan-Plus (average variable cost = $6), let alone total cost (average total cost = $11).

Feet-First Pharmaceutical clearly incurs an economic loss on each ounce of Amblathan-Plus produced and sold. In fact, if Feet-First Pharmaceutical produces 2 ounces of Amblathan-Plus, then its total cost is $22, but its total revenue is only $11. It incurs an economic loss of $11, a loss of $5.50 per ounce produced.

The Short-Run Choice

As such, Feet-First Pharmaceutical is faced with a comparison between the loss incurred from producing with the loss incurred from not producing. Those are its two short-run choices. If it produces, it incurs a loss of $11. If it does not produce, it incurs a loss of $10.

The choice seems relatively obvious: Feet-First Pharmaceutical is better off not producing any Amblathan-Plus, incurring an economic loss of $10, and hoping for an increase in the demand. Should it produce any Amblathan-Plus, it incurs a greater loss than just paying total fixed cost.

Feet-First Pharmaceutical does not produce in the short run because it does not generate enough revenue to pay its variable cost, let alone any part of fixed cost. By producing 2 ounces of Amblathan-Plus, it generates $11 of total revenue. This revenue not only falls short of covering the $22 of total cost, neither is it enough to pay the $12 of total variable cost. This is why the economic loss from production is greater than total fixed cost.