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IAI Actuarial Core Principles · Business Economics · Profit maximisation under perfect competition and monopoly

A firm in a perfectly competitive market is producing at an output where marginal revenue exceeds marginal cost, and marginal cost is rising. Which action will raise its profit?

The firm should increase output until marginal cost rises to equal the market price. While MR exceeds MC each additional unit adds to profit, and under perfect competition MR equals price, so expansion continues until MC equals price.

  1. AIncrease output until marginal cost equals the market priceCorrect
  2. BReduce output until marginal cost falls to a lower level
  3. CRaise the selling price above the market price
  4. DShut down immediately in the short run
  5. Hold output unchanged because profit is already maximised

Explanation

When MR exceeds MC, each extra unit adds more to revenue than to cost, so output should expand. For a perfectly competitive firm MR equals price, so it expands until MC rises to equal price. Raising price above the market price would lose all sales, since the firm is a price taker.

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