Saved Bookmarks
| 1. |
Can there be a positive level of output that a profit-maximizing firm produces in a competitive market at which market price is not equal to marginal cost? Give an explanation. |
|
Answer» SOLUTION :The profit MAXIMIZING level of output is always determined where, (i) MR=MC (ii) MC MUST be rising. In other words, where price is equal to MC. If price is not equal to MC, profit maximizing condition cannot hold. It can be explained with the help of the following two cases: Case 1: Price Greater Than MC (i) In the given figure at output level `q_(2)`, the market price is greater than MARGINAL cost. (ii) To show that q, is not a profit maximizing level of output, we have taken `q_(3)` output level, which is right of `q_(2)`. (iii) Suppose the firm increases its output level from `q_(2)` to `q_(3)`. The increase in total revenue of the firm from this output is the market price multiplied by the change in quantity (`DeltaTR`= market price `xxDeltaQ`), that is the area of rectangle `q_(2)q_(3)CB`.  (iv) On the other hand, the increase in total cost with this increase in output is the area of the region `q_(2)q_(3)XW`. (v) But, a comparison of the two area shows that the firm.s profit is higher when output level is `q_(3)` rather than `q_(2)` So, `q_(2)` is not a profit maximizing levelof output. Case 2: Price Less Than MC (i) In the given figure at output level `q_(2)`, the market price is less than marginal cost. (ii) To show that `q_(2)` is not a profit maximizing level of output, we have taken `q_(3)` output level, which is LEFT of `q_(2)`.  (iii) Suppose now, that the firm reduce its output level from `q_(2)` to `q_(3)`. The decrease in total revenue of the firm from this output is the market price multiplied by the change in quantity (`DeltaTR=` market price `xxDeltaQ` ), that is the area of rectangle `q_(2)q_(3)CB`. (iv) On the other hand, the decrease in total cost with this decrease in output is the area of the region `q_(2)q_(3)WX`. But, a comparison of the two area shows, that by reducing the output from `q_(2)` to `q_(3)`, the decrease in cost is more than the loss in revenue. So, `q_(2)` is not a profit maximizing level of output. |
|