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The profit-maximizing level of output is a production level that

achieves the greatest level of economic profit given existing


market conditions and production cost. For a perfectly
competitive firm, this entails adjusting the production level in
response to the going market price.

Profit Maximization
Profit Curve

Three Views
Profit-maximizing output can be identified in one of three
ways--directly with economic profit, with a comparison of total
revenue and total cost, and with a comparison of marginal
revenue and marginal cost.
Total Curves
This exhibit illustrates how it can be identified for a perfectly
competitive firm, such as that operated by Phil the zucchini
growing gardener. Phil sells zucchinis in a market with gad
zillions of other zucchini growers and thus faces a going
market price of $4 for each pound of zucchinis sold.
The top panel presents the profit curve. The middle panel
presents total revenue and total cost curves. The bottom panel
presents marginal revenue and marginal cost curves. In all
three panels, Phil maximizes when producing 7 pounds of
zucchinis.

Profit: First, profit maximization can be illustrated


with a direct evaluation of profit. If the profit curve is
at its peak, then profit is maximized. In the top panel,
the profit curve achieves its highest level at 7 pounds
Marginal Curves
of zucchinis. At other output levels, profit is less.
Total Revenue and Total Cost: Second, profit
maximization can be identified by a comparison of
total revenue and total cost. The quantity of output
that achieves the greatest difference of total revenue
over total cost is profit maximization. In the middle
panel, the vertical gap between the total revenue and
total cost curves is the greatest at 7 pounds of
zucchinis. For smaller or larger output levels, the gap
is either less or the total cost curve lies above the total
revenue curve.
Marginal Revenue and Marginal Cost: Third, profit
maximization can be identified by a comparison of
marginal revenue and marginal cost. If marginal
revenue is equal to marginal cost, then profit cannot
be increased by changing the level of production.
Increasing production adds more to cost than
revenue, meaning profit declines. Decreasing production subtracts more from revenue than from cost,
meaning profit also declines. In the bottom panel, the marginal revenue and marginal cost curves
intersect at 7 pounds of zucchinis. At larger or smaller output levels, marginal cost exceeds marginal
revenue or marginal revenue exceeds marginal cost.

More on the Marginal View


Further analysis of the marginal approach to analyzing profit maximization provides further insight into the
short-run production decision of a perfectly competitive firm.
First, consider the logic behind using marginals to identify profit maximization.
1.
2.

Marginal revenue indicates how much total revenue changes by producing one more or one less unit
of output.
Marginal cost indicates how much total cost changes by producing one more or one less unit of
output.

3.
4.
5.

Profit increases if marginal revenue is greater than marginal cost and profit decreases if marginal
revenue is less than marginal cost.
Profit neither increases nor decreases if marginal revenue is equal to marginal cost.
As such, the production level that equates marginal
revenue and marginal cost is profit maximization.

With this in mind, now consider this exhibit to the right, which
will eventually contain the marginal revenue and marginal cost
curves for Phil's zucchini production.

Profit Maximization,
The Marginal View

Marginal Revenue: Because Phil is a price taker, his


marginal revenue curve is a horizontal line. Click the
[Marginal Revenue] button to reveal this curve. It is
perfectly elastic at the going market price of $4 per
pound of zucchinis.
Marginal Cost: The marginal cost curve is U-shaped,
reflecting the principles of short-run production. Click
the [Marginal Cost] button to add this curve to the
diagram. It has a negative slope for small amounts of
output, and then the slope is positive for larger
quantities due to the law of diminishing marginal
returns.
Profit Maximization: Profit is maximized at the
quantity of output found at the intersection of the
marginal revenue and marginal cost curves, which is 7
pounds of zucchinis. Click the [Profit Max] button to
highlight this production level. This is the same profitmaximizing level identified using the total revenue and total cost curves and the profit curve.

Consider what results if marginal revenue is not equal to marginal cost:

If marginal revenue is greater than marginal cost, as is the case for small quantities of output, then the
firm can increase profit by increasing production. Extra production adds more to revenue than to cost,
so profit increases.
If marginal revenue is less than marginal cost, as is the case for large quantities of output, then the
firm can increase profit by decreasing production. Reducing production reduces revenue less than to it
reduces cost, so profit increases.
If marginal revenue is equal to marginal cost, then the firm cannot increase profit by producing more
or less output. Profit is maximized.

With this in mind, now consider this exhibit to the right, which
will eventually contain the marginal revenue and marginal cost
curves for Manny Mustard's sandwich production.

Profit Maximization,
The Marginal View

Average Revenue: First up is the average


revenue curve, which can be seen with a click of the
[Average Revenue] button. Because Manny Mustard is
a monopolistically competitive firm, this average
revenue curve is also its negatively-sloped demand
curve.
Marginal Revenue: A click of the [Marginal Revenue]
button reveals the green line labeled MR that depicts
the marginal revenue Manny receives from sandwich
production. Because Manny is a price maker, this
marginal revenue curve is also a negatively-sloped line,
and it lies beneath the average revenue (and demand) curve. However, because Manny's demand
relatively elastic, these two curves are close together.

Marginal Cost: A click of the [Marginal Cost] button reveals a red U-shaped curve labeled MC that
represents the marginal cost Manny incurs in the production of sandwiches. The shape is based on
increasing, then decreasing marginal returns.
Profit Maximization: Profit is maximized at the quantity of output found at the intersection of the
marginal revenue and marginal cost curves, which is 6 sandwiches. Click the [Profit Max] button to
highlight this production level. This is the same profit-maximizing level identified using the total
revenue and total cost curves and the profit curve.

Consider what results if marginal revenue is not equal to marginal cost:

If marginal revenue is greater than marginal cost, as is the case for small quantities of output, then the
firm can increase profit by increasing production. Extra production adds more to revenue than to cost,
so profit increases.
If marginal revenue is less than marginal cost, as is the case for large quantities of output, then the
firm can increase profit by decreasing production. Reducing production reduces revenue less than it
reduces cost, so profit increases.
If marginal revenue is equal to marginal cost, then the firm cannot increase profit by producing more
or less output. Profit is maximized.

Once the profit maximizing output is revealed, the last step is to identify the price charged by Manny. This is
easily accomplished by clicking the [Price] button. Price is found by extending the 6-sandwich quantity upward
to the average revenue curve, which is the demand curve. Buyers are willing to pay $4.95 per sandwich if 6
sandwiches are sold.
Note that this $4.95 price is greater than the $4.65 marginal cost, which indicates that monopolistic
competition does not technically achieve the price-equals-marginal-cost condition for efficiency. However,
because the demand curve is relatively elastic, the difference is small.