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Difficulty: EasyPerfect Competition: Price and Output Determination in Short and Long Run

In a perfectly competitive market, a profit-maximizing firm determines its short-run equilibrium output level by setting its marginal cost equal to which of the following?

  1. Marginal revenueAnswer
  2. B
    Total revenue
  3. C
    Average fixed cost
  4. D
    Average total cost

Answer

Marginal revenue
Under perfect competition, the firm faces a horizontal demand curve where market price equals marginal revenue (P=MRP = MR). The general profit-maximization rule for any firm is to produce where marginal cost equals marginal revenue (MC=MRMC = MR). Therefore, the firm sets marginal cost equal to marginal revenue to determine its equilibrium output.

Step-by-Step Solution

1
Identify the market structure and firm behavior
The firm operates under perfect competition and aims to maximize profit in the short run.
Perfectly competitive firms are price takers, meaning market price (PP) is constant for any level of output sold, making P=MR=ARP = MR = AR.
2
Apply the profit-maximization rule
The necessary equilibrium condition is MR=MCMR = MC.
If MR>MCMR > MC, producing an additional unit adds more to revenue than to cost, increasing profit. If MR<MCMR < MC, the extra unit costs more to produce than it brings in revenue. Thus, profit is maximized where marginal revenue equals marginal cost.

Key Concept

Short-run Profit-Maximizing Condition under Perfect Competition
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Topics

Perfect Competition: Price and Output Determination in Short and Long Run

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