Question

Explain in words why a profit-maximizing firm will not choose to produce at a quantity where marginal cost exceeds marginal revenue.

Short answer

A profit-maximizing firm will not choose to produce at a quantity where marginal cost exceeds marginal revenue because doing so would lead to a decrease in profit. At this point, the cost of producing an additional unit is higher than the revenue generated from selling it, meaning that the firm's profit would be maximized by reducing production. This situation contradicts the firm's goal of maximizing profit, which is achieved when marginal revenue is equal to marginal cost. Therefore, producing at a level where marginal cost exceeds marginal revenue is not an optimal strategy for a profit-maximizing firm.

Step-by-step solution

Understanding Marginal Cost and Marginal Revenue

Marginal cost (MC) represents the cost to produce one additional unit of a good. It plays an important role in determining the optimal quantity of production. Marginal revenue (MR), on the other hand, is the additional revenue a firm earns from selling one more unit of a good. For the firm to maximize its profit, it needs to find the balance between the additional revenue it earns from selling more units and the additional cost incurred to produce those extra units.

Profit Maximization

Profit maximization is the objective of most firms, and it is achieved when the difference between a company's total revenue and total cost is the largest. In other words, profit maximization occurs when the marginal revenue equals the marginal cost. Mathematically, this can be represented as: \[ \text{Maximized Profit} = \text{Total Revenue} - \text{Total Cost} \] And the optimal production point: \[ \text{MR} = \text{MC} \]

Marginal Cost Exceeds Marginal Revenue: Explaining in Words

If a firm chooses to produce at a quantity where marginal cost exceeds marginal revenue, it means that for each additional unit produced, the cost of producing that unit is higher than the revenue it generates. In this case, producing extra units will result in a decrease in profit, as the added cost outweighs the added revenue. In other words, when MC > MR, the firm is not making the best use of its resources. It could actually increase its profit by cutting back on production, as the cost savings from producing fewer units would outweigh the lost revenue. This is why a profit-maximizing firm will not choose to produce at a quantity where marginal cost exceeds marginal revenue; it would be contradictory to their profit-maximization goal. To summarize, a profit-maximizing firm will always aim to produce at a quantity where marginal revenue equals marginal cost. Producing at a point where marginal cost exceeds marginal revenue would result in a decrease in profit, which is not aligned with the firm's objective.