Question

The biggest advantage of the two rules to detect the most profitable output level is that these rules tell us that

1. There are always two output levels at which marginal revenue is equal to marginal cost and we need to identify the correct profit-maximizing level of production by using these two rules.
2. When the two rules are satisfied we know that the maximum total profit cannot be negative.
3. In general, marginal revenue equal to marginal cost does not guarantee profit-maximization.
4. For a company with constant marginal cost, profit-maximization is impossible.
5. The maximization of total revenue or sales is what companies should pursue.

Answer 1

C. In general, marginal revenue equal to marginal cost does not guarantee profit maximisation.

Equality of marginal cost and revenue is not adequate enough for a firm to maximise profits. In some cases it would rather indicate a profit minimisation than profit maximisation. The break even point as envisaged merely shows that costs are equal to revenue but it could be a less optimal level of output for the firm .

In the above diagram, perfect competition is assumed , hence MR is constant , MC or marginal cost curve cuts MR or marginal revenue curve at two points , ‘A’ and ‘B’. However the firm is maximising its profits only at point ‘B’ rather than ‘A’. Though MC = MR at both points. Yet at point ‘A’, the MC curve is the point where the firm is able to break even , probably for the first time== making minimum level of profits. It will be producing ‘Q’, amount of output, at point ‘B’ however, it has expanded to its fullest capacity and earning the maximum profits.