Question

Please explain all in microsoft word

Using real world examples, discuss the notion that for a perfectly competitive firm to maximize profit they must operate at the point where MR=MC which is the same as P=MC.

Answer 1

Perfectly competitive markets rarely exist in real world. However there are certain markets which are near perfect competition. Some example s of it are agricultural products markets, services provided by a hostel in a college etc. These markets provide homogenous products, buyers and sellers have no control over price and information regarding products are fairly known to buyers and sellers.

To maximize profit a firm facing perfect competition ( or even in imperfect competition) MR = MC is the criterion. This is so because at this point (i.e. equilibrium)MC curve cuts MR curve from below. A point above this will mean MC is greater than MR and thus firm will face a loss. A point below it will mean MR is greater than MC but the firm is producing less than its optimum output and thus is losing revenue and profit.

The point will be clear from below graph.

in the above graph we can see that at equilibrium E , MC = MR . at this point quantity Q is producedat price P. In case of point E1 on MC curve, MC is more than MR, thus cost of producing next one unit will be more than revenue earned from it and the firm will face a loss. so the point is not an optimum point of production. at point E2, quantity produced will be Q2 which is less than Q1, also price fetched will be less than optimum price P ( at point E). here MR though is greater than MC but due to less price and less quantity produced the firm will not be able to generate mucn reveue as it can produce at point E. So, for profit maximization MC= MR is a must in a perfectly competitive firm.

In the same graph above we can see that at point E, P (i.e MR curve) is equal to MC. Since all firms in a perfectly competitive market are price takers (i.e. have no influence on market price), the Price curve or MR curve will be a horizontal line as shown in above graph. and we ahve already explained that for perfectly competitive firm proft maximizaton criterion is MC= MR. Now since P = MR in perfect competiton, P = MC is also the criterion for profit maximization for a perfectly competitive firm.