Question

explain why profits are largest when mc=mr and describe how that works in monopolistic competition when the firm can choose the point on market demand where it wishes to operate

Answer 1

The Profit Maximization Theory states that if a company chooses to maximize its income, it must choose the output level where Marginal Cost (MC) is equal to Marginal Revenue (MR) and the curve of Marginal Cost is increasing. In other terms, at a point where MC= MR has to be made.

The profit maximization formula is MC = MR

Marginal Cost is the increase in cost by producing one more unit of the good. The cost of producing and selling more units more decrease when operations are small (because of the ability to better "specialize" limited factors, or by "buying in bulk" to obtain better input prices), but eventually all operations reach a point of decreasing marginal returns, after which more and more inputs are required to squeeze out more production. It means that it will take at least as much cost to produce it as the one before it to manufacture another plate, or sell one more bar of soap.

Marginal Revenue is the change in total revenue as a result of changing the rate of sales by one unit. Marginal Revenue is also the slope of Total Revenue. When quantity increases, marginal revenue (MR) is constant or increasing. That is, as a firm tries to sell more units, it can either sell them at the same cost (especially if they are in a competitive market environment) or sell them at a lower price to complete the sale.

Profit = Total Revenue – Total Costs

Consequently, income maximization occurs at the largest distance or disparity between total revenue and overall cost.

Monopolistic rivalry is the economic market model of similar, but not identical, products being sold by many sellers. The demand curve of monopolistic competition is flexible because while companies sell differentiated goods, many are still near substitutes, so if one company increases the price too high, many of its customers will turn to other companies ' products. This demand elasticity makes it similar to pure competition where there is total elasticity. Demand is not completely elastic because a dominant competitor has less competitors than would be the case for perfect competition, and because to some degree the goods are differentiated, so they are not ideal substitutes.

Monopoly rivalry has a sloping demand curve downwards. Like a mere monopoly, therefore, its average income will always be lower than the market price, because it can only increase demand by lowering prices, but by doing so it must lower the prices of all units of its item. Monopolistically competitive firms either maximize profits and minimize losses by generating that quantity wherever they are.