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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 wants to maximise profit by choosing its output. Which condition identifies the profit-maximising output, provided the firm should operate at all?

Profit is maximised where marginal revenue equals marginal cost, with marginal cost cutting marginal revenue from below. Producing beyond this point adds more cost than revenue, and stopping short forgoes profitable units. Maximum revenue or minimum average cost do not guarantee maximum profit.

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

Explanation

Profit is maximised where the revenue from the last unit equals the cost of producing it (MR = MC), and MC must be rising through MR so that this is a maximum rather than a minimum. Maximising total revenue ignores costs. Minimum average cost gives efficiency, not necessarily maximum profit.

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