22 . ( 3 pts) Under what conditions will a purely competitive firm realize an ec

Question

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

22).

As we know that the “economic profit” is the difference between “TR” and “TC”, => when “TR” is more than “TC”, => the producer is getting positive economic profit and vice versa. Now, in perfectly competitive market the output price is fixed, => “P=AR=MR” and at equilibrium “MR=MC”, => under purely competitive market a firm will earn positive economic profit, if “AR > ATC”, => “P=AR=MR=MC > ATC”.

23).

As we know that under perfect competition “P” is fixed and the objective of the producer is to maximize “profit”, which is the difference between “TR” and “TC”, => here the producer must choose the level of output where the “difference between TR and TC” is maximum and “TR > TC” to maximize profit.

Now, the “MR” is the additional revenue earned by selling additional unit of a good or mathematically it’s a slope of “TR”. Similarly, the “MC” is the additional cost incurred by the producer to produce additional unit of output, or mathematically it’s a slope of “TC”. So, the difference between “TR” and “TC” will be maximum when both of them have the same slope, => at the equilibrium “MR” must be same as “MC”.

24).

We already defined the “MR” and “MC”, => if “MR > MC”, => production of additional unit of output generate more revenue than its cost, => as the producer produce more of output, => profit increases, => as a rational producer it is profitable to increase output. Now, if “MR < MC”, => production of additional unit of output generate less revenue than its cost, => as the producer produce more of output, => profit decreases => as a rational producer it is profitable to reduce output.
So, here the optimum choice to maximize profit is to choose the level if output where “MR” is equal to “MC”.

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