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The general profit-maximizing rule is: Expand your output until you reach the output level at which MR = MC—and stop at that point
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8. The general profit-maximizing rule is: Expand your output until you reach the output level at which MR = MC—and stop at that point.
The profit-maximizing rule for the firm in pure (or perfect) competition: P = MC. This is nothing but a particular instance of the MR = MC rule. It is assumed in pure (or perfect) competition that the demand curve facing the individual firm is perfectly horizontal, or perfectly price- (elastic/inelastic}. That is, if market price is $2, the firm receives (less than $2 /exactly $2/more than $2) for each extra unit that it sells. In this special case, MR (extra revenue per unit) is (greater than/the same thing as/less than) price per unit (which could be called Average Revenue, or revenue per unit). So in pure (or perfect) competition, P == MC and MR = MC are two ways of saying the same thing.
9. In imperfect competition, the firm's demand curve is—and things are different. From inspection of the figures in Table 1 [compare Columns (1) and (6)], it is evident that with such a demand curve, MR at any particular output is (greater than/the same thing as/less than) price for that output.
Why is this so? Suppose, at price $7, you can sell 4 units; at price $6, 5 units. Revenues associated with these two prices are respectively $28 and $30. Marginal Revenue from selling the fifth unit is accordingly $(2/5/6/7/28/30). It is the difference in revenue obtained as a result of selling the one extra unit. Why only $2—when the price at which that fifth unit sold was 86? Because to sell that fifth unit, price had to be reduced. And that lowered price applies to all 5 units. The first 4, which formerly sold at $7, now bring only $6. On this account, revenue takes a beating of $4. You must subtract tins $4 from the $6 which the fifth unit brings in. This leaves a net gain in revenue of $2—Marginal Revenue.
10. To return to the fortunes of the firm in Tables 1 and 2: The tables do not provide sufficient unit-by-unit detail to show the exact Maximum-profit output level. But Table 1 indicates that between sales outputs of 63 and 71, MR is $1.63. The MR figures fall as sales are expanded, so that the $1.63 would apply near the midpoint of this range, say at output 67. It would be somewhat higher between 63 and 66; somewhat lower between 68 and 71.
Similarly, MC (Table 2) would be SI.60 at output of about 67 units. So the Maximum-profit position would fall very close to 67 units produced and sold per period.
To sell this output, the firm would charge a price (see Table 1) of about 8(7 '5.75/4/1.60). Its Total Revenue [look for nearby figures in Column (3)] would be roughly $(380/580/780). Its Total Cost (Table 2) would be roughly ^(310/510/710), leaving profit per period of about $70.
$5.75; $380; $310.
The text notes that in geometric terms Marginal Revenue can be depicted as the slope of the Total Revenue curve.
Tills can be illustrated by looking more carefully at the Total Revenue curve you have drawn in Study Guide Fig. 1. Study Guide Fig. 2 shows an enlargement of a small segment of that curve: that part of the curve between output quantities of 25 and 31. If 25 units are sold, the price is 810 and Total Revenue is $250. This is point A on Fig. 2. If price is reduced to $9, that increases sales by 6 units, from 25 units to 31 units. Thus Total Revenue becomes $279 (31 multiplied by $9). So, if the firm reduces price from $10 to $9, in effect it moves from point A to point B.
Figure 2's heavier, curved line is the smooth curve used to join points A and B. It is an approximation of the points that would be obtained if we had quantity and revenue information on prices such as '59.90, S9.SO, and so on.
There is also a straight line (the thin line) joining A and B. It is close to the probable true Total Revenue curve although it is not likely to be the exact curve.
Instead of dropping from price $10 all the way to $9, suppose we had moved only to (say) $9.60. That would have produced (roughly) a 2-unit increase in quantity demanded. In this way, we would move closer to the true MR figure than our previous 6-unit approximation supplied. In Fig. 2 terms, we would be moving from A only to
D, not from A to B. Notice carefully that the straight line (the thin line) joining A to D becomes a (better/poorer) approximation of the presumed true Total Revenue curve than was the case when the points involved were A and B.
In sum, the closer we move point B to point A (for example, if we make it D rather than B), the closer the slope figure comes to being a measure of the true MR figure. Strictly speaking, we have true MR (the rate of change in revenue as measured in terms of 1-unit output changes) only when the line whose slope is being measured and used to indicate MR is actually tangent to the Total Revenue curve.
In its near-closing section Bygones and Margins, the text chapter emphasizes that if a firm is setting its price and output according to MR = MC principles, it will disregard Fixed Cost.
QUIZ: Multiple Choice
1. If a firm's Marginal Revenue exceeds its Marginal Cost, Maximum-profit rules require that firm to (1) increase its output in both perfect and imperfect competition; (2) increase its output in perfect but not necessarily in imperfect competition; (3) increase its output in imperfect but not necessarily in perfect competition; (4) decrease its output in both perfect and imperfect competition; (5) increase price, not output, in both perfect and imperfect competition.
2. Whenever a firm's demand curve is horizontal or "perfectly elastic," then (1) the firm cannot be operating under conditions of perfect competition; (2) the profit-maximizing rule of MR-equal-to-MC does not apply; (3) price and Marginal Revenue-must be one and the same; (4) price and Marginal Cost must be one and the same; (5) none of the above is necessarily correct.
3. A basic difference between the firm in perfect (or pure) competition and the monopoly firm, according to economic analysis, is this: (1) The perfect competitor can sell as much as he wishes at some given price, whereas the monopolist must lower his price whenever he wishes to increase the amount of his sales by any significant amount;
(2) the monopolist can always charge a price that brings him a substantial profit, whereas the perfect competitor can never earn such a profit; (3) the elasticity of demand facing the monopolist is a higher figure than the elasticity of demand facing the perfect competitor; (4) the monopolist seeks to maximize profit, whereas the perfect competitor's rule is to equate price and Average Cost; (5) none of the above.
4. "Oligopoly" means (1) the same thing as imperfect competition; (2) a situation in which the number of competing firms is large but the products differ slightly; (3) a situation in which the number of competing firms is small;
(4) that particular condition of imperfect competition which is just removed from monopoly, regardless of the number of firms or type of product: (5) none of these.
5. When a monopoly firm seeking to maximize its profits has reached its "equilibrium position," then (1) price must be less than Marginal Cost; (2) price must be equal to Marginal Cost; (3) price must he greater than Marginal Cost; (4) price may be equal to or below Marginal Cost, but not above it; (5) none of the above is necessarily correct since equilibrium does not require any particular relation between price and Marginal Cost.
6. To explain why imperfect competition is far more prevalent than perfect competition, the text lays considerable emphasis upon the following: (1) the fact that Marginal Revenue is less than price; (2) the tendency of Marginal Cost to continue to fall over substantial levels of output produced; (() the disposition of firms to try to maximize the profit they can gain from sales; (4) the tendency of Marginal Cost to rise after some particular level of output produced has been reached; (5) the fact that large firms now typically produce many different products, thus squeezing smaller firms out of their markets.
7. Among the five statements below, one must be false with respect to any firm operating under conditions of imperfect competition. Which one? (1) The number of competing sellers offering similar (although differentiated) products can be large. (2) Other firms may sell products
which are identical or almost identical with this firm's product. (3) The number of competing sellers offering similar (although differentiated) products can be small. (4) The firm's Marginal Revenue will be less than the price it obtains. (5) The demand curve facing the firm can be perfectly horizontal.
8. A level of output for a firm at which Marginal Cost had risen to equality with price would (1) be a profit-maximizing output level in both pure (or perfect) competition and imperfect competition; (2) be a profit-maximizing output level in pure (or perfect) competition but not in imperfect competition; (3) not be a profit-maximizing output level either in perfect or in imperfect competition; (4) be a profit-maximizing output level in imperfect competition but not in pure (or perfect) competition; (5) definitely be a profit-maximizing output level in imperfect competition, but might or might not be in pure (or perfect) competition.
9. A firm in conditions of imperfect competition which finds itself at an output level where Marginal Cost has risen to equality with price, and which wants to maximize its profit, ought to (1) increase its output; (2) change (either increase or decrease) its price but not its output; (3) maintain both price and output at their present levels; (4) increase its price; (5) perhaps do any of the above—information furnished is insufficient to tell.
10. The essence of the general rule for maximizing profits given in the text chapter is that a firm should set its price, or its output, as follows: set its (1) price at a level where the excess over the minimum-possible level of Average Cost is at its maximum; (2) output at a level where the extra production cost resulting from the last unit produced just equals the extra revenue brought in by that last unit; (3) price at the highest level which the traffic will bear; (4) price at a level just equal to Marginal Cost (assuming that Marginal Cost would rise with any increase in output); (5) output at a level where Average Cost is at a minimum.
11. A firm would be designated as a monopoly, according to the definition conventionally used by economists, in any situation where (1) the firm's Marginal Revenue exceeds the price it charges at all levels of output (other than the first unit sold); (2) the firm's Marginal Revenue is less than the price it charges at all levels of output (other than the first unit sold); (3) the firm has at least some degree of control over the price that it can charge; (4) the profit earned by the .firm significantly exceeds the competitive rate of return, after proper allowance has been made for risk undertaken; (5) there is no other firm selling a close substitute for the product of this firm.
12. The Marginal Revenue (MR) associated with any given point on a firm's demand curve will be related to the elasticity of demand at that point (with respect to price) as follows:
(1) When demand is inelastic, MR will be negative in value;
(2) when demand is elastic, MR will be negative in value;
(3) when demand is inelastic, MR will be zero in value; (4)
when demand is elastic, MR will be zero in value; (5) .VR of monopoly or imperfect competition. The AR line is Aver-is always positive in value (although below price) regardless age Revenue—in other words, it is price obtainable per unit. of elasticity, except at the point or region of unit elastic
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