Overview
This lecture explains how a firm determines the quantity to produce in order to maximize profit, focusing on the relationship between marginal cost and marginal revenue in a competitive market.
Costs and Revenue
- Marginal cost (MC) is the cost of producing one additional unit and depends on quantity.
- Average total cost (ATC) is total cost divided by quantity produced.
- Profit is calculated as total revenue minus total costs.
- Total revenue is the amount a firm brings in from selling its product.
Introducing Marginal Revenue
- Marginal revenue (MR) is the additional revenue from selling one more unit.
- In a perfectly competitive market, the firm is a price taker, so MR equals the constant market price per unit.
Profit Maximization Rule
- A firm should continue producing as long as MR exceeds MC for additional units.
- The profit-maximizing quantity is where MC equals MR.
- Producing beyond MR = MC results in losses on additional units because MC exceeds MR.
- Producing less than MR = MC means missing out on potential profit.
Calculating Profit
- At the optimal output, profit per unit is the difference between average revenue (same as price/MR) and ATC.
- Total profit is this per-unit profit multiplied by quantity produced (area of a rectangle on a cost diagram).
Key Terms & Definitions
- Marginal Cost (MC) — Cost of producing one more unit of output.
- Marginal Revenue (MR) — Additional revenue from selling one more unit.
- Average Total Cost (ATC) — Total cost divided by quantity produced.
- Profit — Total revenue minus total costs.
- Price Taker — A firm that cannot set its own price and must accept the market price.
Action Items / Next Steps
- Review diagrams showing MC, MR, and ATC to visualize profit maximization.
- Practice calculating profit and identifying the profit-maximizing output from cost and revenue data.