20 . ( 5 pts) Explain the marginal revenue and marginal cost approach to profit
ID: 1164126 • Letter: 2
Question
20. ( 5 pts) Explain the marginal revenue and marginal cost approach to profit maximization and use it to describe profit, loss, and shut down situations for the purely competitive firm.
The purely competitive firm operating in the short run is a price taker that can maximize profits (or minimize losses) only by changing its level of output. The marginal revenue–marginal cost approach to profit maximization basically sets the level of output at the quantity where marginal revenue (or price) (greater than, equal to, less than) marginal cost. ( MR ( P) MC )
Indicate with signs such as >, < and =.
What are three possible cases to consider when using this approach?
1) The firm will maximize profits when MR=MC at an output level where price is (greater than, equal to, less than) than average total cost (ATC).
2) The firm will minimize losses when MR=MC at that output level where price is (greater than, equal to, less than) than the minimum AVC (but (greater than, equal to, less than) than ATC).
3) The firm will shut down when MR=MC at an output level where price is (greater than, equal to, less than) than average variable cost (AVC).
21. ( 2 pts) What conditions are necessary to determine if the purely competitive firm should produce in the short run? State the marginal revenue and marginal cost conditions and the total revenue and total cost conditions.
From TR-TC perspective, the firm should produce if TR exceeds TC (TR>TC), or if TC exceeds TR by some amount less than ( AVC, AFC, TFC, MC).
From an MR-MC perspective, the firm should produce if price is equal to, or greater than, the minimum ( AVC, AFC, TFC, MC).
22. ( 3 pts) Under what conditions will a purely competitive firm realize an economic profit? Give a response from a marginal revenue and marginal cost perspective and from a total revenue and total cost perspective.
From a TR-TC perspective, the firm will realize an economic profit if ( TR, TC ) exceeds ( TR, TC ). It will experience economic losses if ( TR, TC ) exceeds ( TR, TC ).
From an MR-MC perspective, the firm will realize an economic profit if ( price, ATC ) exceeds ( price, ATC ). It will experience economic losses if ( price, ATC ) exceeds ( price, ATC ).
23. ( 2 pts) What quantity should the purely competitive firm produce to maximize profits? Analyze from a total revenue and total cost perspective and a marginal revenue and marginal cost perspective.
From a TR-TC perspective, the firm should produce where the excess of TR over TC is a maximum or where the excess of TC over TR is a minimum (and (greater than, equal to, less than) total fixed costs).
From an MR-MC perspective, the firm should produce where MR or price equals ( ____ ).
24. ( 2 pts) Why is the level of output at which marginal revenue equals marginal cost the profit-maximizing output?
The easiest way to explain this is to explain why it cannot be otherwise. If marginal revenue exceeds marginal cost, then the firm can add to its profits by expanding production until marginal revenue no longer exceeds marginal cost (either because the price declines eventually or diminishing returns set in and marginal cost rises or both). If, on the other hand, marginal revenue is below marginal cost, it would not be rational for the firm to expand production to this level. Why add more to your costs than you add to your revenues since that means smaller profits? If the firm would not produce when marginal revenue exceeds marginal cost, or when marginal revenue is less than marginal cost, then it must maximize profits where marginal revenue (greater than, equal to, less than) marginal cost.
Explanation / Answer
20)
Firms in perfectly competitive market maximizes their profits by equating P =MC, firms are price takers in market.
Price may be equal or less or greater than ATC. Firm will incur losses if price happens to be less than ATC.
ATC = P (No Loss)
ATC >P (Loss)
ATC<P (Profit)
Right option is (1)
21)
Through the TR and TC approach, firm should continue to produce as long as TR equal to or greater than total Variable cost (TVC).
TR >TVC
Or
Through MR and MC approach level of price not fall below the Average variable cost.
P = or > AVC.
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