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IAI Actuarial Core Principles · Business Economics · Production, costs, revenue and profit in price and output decisions

A firm in a competitive market is deciding how many units to produce. Which condition identifies the output at which it maximises profit, assuming it should produce at all?

Profit is maximised where marginal cost equals marginal revenue, with marginal cost rising through marginal revenue. Up to that point each extra unit adds more to revenue than to cost, and beyond it each unit adds more to cost than to revenue.

  1. AAverage cost equals average revenue at its lowest point
  2. BMarginal cost equals marginal revenue, with marginal cost rising through marginal revenueCorrect
  3. CTotal revenue is at its maximum
  4. DAverage cost is at its minimum
  5. Marginal revenue equals zero

Explanation

Profit rises while each extra unit adds more revenue than cost (MR > MC) and falls once MC exceeds MR. Profit is therefore greatest where MC = MR with MC cutting MR from below. Maximising revenue (MR = 0) ignores cost, so it is wrong.

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