Question

A purely competitive firm whose goal is to maximize profit will choose to produce the amount of output at which: LO10.4 a. TR and TC are equal. b. TR exceeds TC by as much as possible. c. TC exceeds TR by as much as possible. d. none of the above.

Short answer

b. TR exceeds TC by as much as possible.

Step-by-step solution

Understand Profit Maximization

Profit is calculated as Total Revenue (TR) minus Total Cost (TC). To maximize profit, a competitive firm seeks to have the largest possible difference where TR exceeds TC, maximizing the gap between the two measures.

Analyze the Options

Evaluate each option provided to see which best describes the condition where a firm maximizes its profit. - Option a suggests TR equal to TC, which results in zero profit. - Option b suggests TR exceeds TC by the greatest amount, which aligns with profit maximization. - Option c suggests TC exceeds TR, resulting in a loss. - Option d offers no defined scenario for profit maximization.

Select the Best Option

Compare all options. Option b fits the condition of maximizing the gap between TR and TC, which aligns with profit maximization. Thus, the correct option is "b. TR exceeds TC by as much as possible.”

Key concepts

Understanding Total Revenue

Total Revenue (TR) is the income a firm generates from selling its products or services over a particular period. It is calculated by multiplying the price per unit by the number of units sold. For instance, if a firm sells 100 units of its product at $10 each, the total revenue would be calculated as:\[TR = P \times Q\]Where \( P \) represents the price per unit and \( Q \) denotes the quantity sold. Simple, right? The basic idea here is that for firms operating in a competitive market, increasing total revenue might involve adjusting the quantity produced or the selling price, which usually depends on the market demand and supply conditions. When thinking about profit maximization, businesses consider how changes in TR compare to changes in total cost.

Grasping Total Cost

Total Cost (TC) refers to the total expenditure a firm incurs in the production of goods or services. It can be broken down into two main components:

• Fixed Costs (FC): These are costs that do not change with the level of output, such as rent, salaries, and insurance.
• Variable Costs (VC): These change according to the level of production, like raw materials and direct labor expenses.

The sum of fixed and variable costs gives the total cost:\[TC = FC + VC\]For a firm to maximize profits, it has to ensure that while increasing production and sales (hence TR), it manages the total costs effectively. This involves operating efficiently to minimize unnecessary expenses, choosing cost-effective suppliers, and optimizing production processes.

Characteristics of a Competitive Firm

A competitive firm operates in a market where:

• There are many sellers and buyers, such that no single firm has substantial influence over the market price.
• The products are homogeneous, meaning they are identical or very similar across firms.
• There is free entry and exit in the market, allowing new firms to enter if profits are attractive and leave if losses occur.
• Information is transparent, meaning all participants have access to key market information.

In such a setting, a firm cannot set the price higher than the market price because consumers would simply switch to a competitor. Due to these characteristics, firms focus on optimizing production to minimize costs and maximize profits through the efficient allocation of resources. The profit maximization condition in a competitive firm is achieved when Total Revenue far exceeds Total Cost, ensuring the largest possible profit margin.