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Profit Maximization Occurs at The Rate of Output at Which Marginal Revenue Equals Marginal Cost

This document discusses key concepts related to perfect competition and profit maximization for firms. It explains that under perfect competition, firms are price takers rather than price makers due to large numbers of homogeneous firms and buyers/sellers with access to information. The document also discusses profit-maximizing production rates occurring where marginal revenue equals marginal cost. It defines related terms like marginal revenue, marginal cost, average variable cost, and short-run supply curves representing marginal cost above the intersection with average variable cost.

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87 views2 pages

Profit Maximization Occurs at The Rate of Output at Which Marginal Revenue Equals Marginal Cost

This document discusses key concepts related to perfect competition and profit maximization for firms. It explains that under perfect competition, firms are price takers rather than price makers due to large numbers of homogeneous firms and buyers/sellers with access to information. The document also discusses profit-maximizing production rates occurring where marginal revenue equals marginal cost. It defines related terms like marginal revenue, marginal cost, average variable cost, and short-run supply curves representing marginal cost above the intersection with average variable cost.

Uploaded by

iris
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Perfect competition A market structure in which the decisions of individual buyers and sellers have no effect on market price.

Price taker A perfectly competitive firm that must take the price of its product as given because the firm cannot influence its price.
Perfectly competitive firm A firm that is such a small part of the total industry that it cannot affect the price of the product it sells.
Let’s examine why a firm in a perfectly competitive industry is a price taker.
1. There are large numbers of buyers and sellers.
2. The product sold by the firms in the industry is homogeneous.
3. Both buyers and sellers have access to all relevant information.
4. Any firm can enter or leave the industry without serious impediments.

Profit-maximizing rate of production The rate of production that


maximizes total profits, or the difference between total revenues
and total costs. Also, it is the rate of production at which marginal
revenue equals marginal cost.
Marginal revenue The change in total revenues resulting from a
one-unit change in output (and sale) of the product in question.
law of diminishing marginal product, the marginal cost curve first
falls and then starts to rise, eventually intersecting the marginal
revenue curve and then rising above it.
Profit maximization occurs at the rate of output at which
marginal revenue equals marginal cost.
When MC is greater than MR, each unit produced adds more to
total cost than to total revenues, so this unit should not be
produced.

As long as the price per unit sold exceeds the average variable
cost per unit produced, the earnings of the firm’s owners will
be higher if it continues to produce in the short run than if it
shuts down.
Short-run break-even price The price at which a firm’s total
revenues equal its total costs. At the break-even price, the firm
is just making a normal rate of return on its capital investment.
(It is covering its explicit and implicit costs.)
Short-run shutdown price The price that covers average
variable costs. It occurs just below the intersection of the
marginal cost curve and the average variable cost curve.
The firm will be making zero economic profits but a 10 percent
accounting profit.
By definition, then, a firm’s short-run supply curve in a competitive
industry is its marginal cost curve at and above the point of intersection
with the average variable cost curve.
Industry supply curve The locus of points showing the minimum prices
at which given quantities will be forthcoming; also called the market
supply curve.

Long-run industry supply curve A market supply curve showing the


relationship between prices and quantities after firms have been
allowed the time to enter into or exit from an industry, depending on
whether there have been positive or negative economic profits.

Increasing-cost industry An industry in which an increase in industry


output is accompanied by an increase in longrun per-unit costs, such
that the long-run industry supply curve slopes upward.
Decreasing-cost industry An industry in which an increase in output leads to a reduction in long-run per-unit costs, such that the
long-run industry supply curve slopes downward.
Marginal cost pricing A system of pricing in which the price charged is equal to the opportunity cost to society of producing one
more unit of the good or service in question. The opportunity cost is the marginal cost to society

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