Question

Show and explain how you can use information about revenue and costs to find the point of maximum profit for a firm in a perfectly competitive market?

Answer 1

The profit-maximizing point for a perfectly competitive firm occurs at the level where marginal revenue is equal to marginal cost (MR = MC). This is explained in the diagram below.

Since a firm in a perfectly competitive market is a price taker. Hence the marginal revenue curve is the same as the price line (P=MR=AR). The Marginal cost curve, Average total cost, and the average cost curves are the usual U-shaped curves. Now, we know that TR = AR*Q and also TC = ATC*Q. Profit = TR -TC. So, a profit-maximizing firm ideally tries to maximize the difference between these two values.

Now, consider the point MR =MC. In this case, TR is the area of the rectangle APOQ. (O is the origin) and TC is the area of the rectangle CBQO. (Refer to the diagram). So, it can be clearly seen that the profit (TR-TC) is the area of rectangle PABC. At any point other than MR=MC the difference between TR and TC will be less than the area PABC. So, the profit is maximum when MR=MC. Given the firms' MR and MC one can easily find the profit-maximizing output.

If this answer was helpful then please give an upvote