The profit-maximizing firm will adjust production to that point at which
A) total revenue is maximized
B) average variable costs are minimized
C) marginal costs are equal to average total costs
D) marginal costs equal marginal revenue
E) average variable costs are equal to marginal cost
The correct answer and explanation is:
The correct answer is D) marginal costs equal marginal revenue.
A profit-maximizing firm will adjust its production level until marginal cost (MC) equals marginal revenue (MR). Marginal cost refers to the additional cost incurred from producing one more unit of output, while marginal revenue refers to the additional revenue generated from selling one more unit. To maximize profit, a firm must ensure that the cost of producing an extra unit is exactly equal to the revenue it earns from that unit. If marginal cost is greater than marginal revenue, the firm is producing too much and should decrease output to avoid losses. If marginal revenue exceeds marginal cost, the firm is not producing enough and should increase output to capture more profit.
This condition holds in both perfect competition and monopolistic competition, though in a perfectly competitive market, price (P) equals marginal revenue. In contrast, a monopoly or monopolistic competitor has some price-setting power, so marginal revenue is less than the price. However, the principle remains the same: profit maximization occurs when the cost of producing one more unit is equal to the revenue it generates.
In summary, a firm maximizes profit when it produces the quantity of goods where marginal cost equals marginal revenue. If this condition is met, the firm is efficiently allocating resources and ensuring that each unit of output contributes optimally to overall profitability.