Overview
This lecture explains how a perfectly competitive firm determines the profit-maximizing quantity using both the total cost/revenue method and the marginal revenue/marginal cost method.
Total Cost and Total Revenue Method
- Profit is calculated as total revenue minus total cost for each output level.
- Total revenue is found by multiplying the market price by the quantity sold.
- Profit is maximized at the quantity where the difference between total revenue and total cost is greatest.
- Due to increasing marginal costs (from diminishing marginal returns), producing more is not always better.
- In table-based problems, the maximum profit may occur at two adjacent output levels (e.g., 70 or 80 units).
Marginal Cost and Marginal Revenue Method
- Marginal revenue (MR) is the additional revenue from selling one more unit; in perfect competition, MR equals the market price.
- Marginal cost (MC) is the change in total cost divided by the change in quantity.
- Firms should increase production as long as MR > MC; stop when MR = MC.
- Producing more than the MR = MC point reduces profit since MC will exceed MR.
- Graphically, profit is maximized where the MC curve intersects the (horizontal) MR curve.
Graphical Representation
- Total revenue is a straight line due to constant price; total cost is a curved line reflecting increasing marginal costs.
- The optimal output is where the vertical gap between total revenue and total cost is largest.
- Using curves allows for an exact (continuous) answer, not just approximate table-based answers.
Key Terms & Definitions
- Perfect Competition — A market with many buyers and sellers where firms sell identical products at the market price.
- Total Revenue (TR) — Price times quantity sold.
- Total Cost (TC) — Fixed cost plus variable cost at each output level.
- Profit — Total revenue minus total cost.
- Marginal Revenue (MR) — Extra revenue from selling one additional unit (equals price in perfect competition).
- Marginal Cost (MC) — The increase in total cost from producing one more unit.
- Diminishing Marginal Returns — Additional units are more costly to produce due to less efficient use of resources.
Action Items / Next Steps
- Practice finding the profit-maximizing output where MC = MR using both tables and cost curves.
- Complete assigned homework using graphical methods for profit maximization.