Question

If a firm is producing a level of output at which that output's marginal cost is less than the price of the good, (LO3) a) it is producing too much to maximize its profits b) it is probably maximizing its profits c) higher profits could be obtained with increased production d) none of the above

Short answer

Based on the analysis, the correct statement is: c) higher profits could be obtained with increased production This is because the marginal cost of the output is less than the price of the good, which means that producing and selling more units of output would result in more profit for the firm.

Step-by-step solution

Understanding Marginal Cost, Price, and Profit Maximization

Marginal cost is the increase in total cost that results from producing one more unit of output. Firms try to maximize their profits, which occurs when the difference between revenue and cost is the greatest. As the firm produces more output, the marginal cost may increase or decrease, but eventually, it will increase. The price of a good represents the money received from selling one unit of the output. If the marginal cost of producing a unit is less than its price, the firm gains higher profit from producing and selling that extra unit. Now let's analyze each statement given in the exercise.

Analyzing Statement (a)

If a firm is producing too much to maximize its profits, it would mean that reducing its output level would actually result in higher profits. However, the exercise states that marginal cost is less than the price, which means the firm actually gains more profit from selling extra units of output. So, this statement cannot be correct.

Analyzing Statement (b)

If a firm is probably maximizing its profits, it would mean that by producing this level of output, the firm is maximizing the difference between its revenue and cost. We know that the marginal cost is less than the price, which implies that producing more would actually result in more profit. Hence, this statement cannot be correct either.

Analyzing Statement (c)

If higher profits can be obtained with increased production, it suggests that by increasing its output level and manufacturing more units, the firm can increase its profit. Given that the marginal cost of output is less than the price of the good, producing more would result in more profit. Therefore, this statement seems to be correct.

Analyzing Statement (d)

If none of the above statements were correct, it would mean the relationship between marginal cost, price, and profit maximization cannot be determined based on the given information. However, we identified that statement (c) is indeed consistent with the given information, so this statement cannot be correct.

Choosing the Correct Statement

Based on our analysis, we can conclude that the correct statement is: c) higher profits could be obtained with increased production This is because the marginal cost of the output is less than the price of the good, which means that producing and selling more units of output would result in more profit for the firm.

Key concepts

Profit Maximization

Profit maximization is a fundamental goal for any firm. It involves finding the output level at which the difference between total revenue and total costs is the greatest. At this level, a firm maximizes its profit.
When the marginal cost, which is the cost of producing an additional unit, is less than the price of the good, it indicates that there is more profit to be made by producing and selling more units of output.
For a firm, profit maximization means evaluating when producing additional units no longer increases total profit. It seeks the equilibrium where the costs meet the revenues most beneficially.

Output Level

The output level is important in determining how much a firm should produce. It is intricately tied to the concept of marginal cost and profit maximization.
The exercise highlighted that when a firm's marginal cost is less than the price of the good, increasing the output level can increase profits. Simply put:

• If marginal cost < price: Produce more to increase profit.
• If marginal cost = price: This is the profit-maximizing output level.
• If marginal cost > price: Producing more decreases profit.

The output level should be adjusted based on these marginal cost observations to optimize profits.

Revenue and Cost

Revenue and cost are central to understanding profits. Revenue is the income from selling goods, while costs include all expenses incurred in production.
Analyzing these helps determine the financial health and profitability of a firm.
When assessing profit maximization:

• The revenue from selling one additional unit must exceed its cost of production for a firm to increase its profit.
• Marginal cost being less than price means the revenue of the additional unit surpasses the cost.

Regular evaluation allows firms to decide when to expand or reduce production.

Firm Production Analysis

Firm production analysis involves looking at a firm's overall production strategy and its efficiency in maximizing profits. It assesses whether a firm is optimally utilizing its resources.
This analysis includes looking into:

• The balance between costs incurred and revenue generated.
• How changes in production levels affect profitability, taking into account marginal costs.
• Adjustments needed for the production level to achieve profit maximization.
  

By frequently analyzing their production, firms ensure they are on the path to achieving their economic goals efficiently and effectively.