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 result in the additional cost of producing one more unit being greater than the additional revenue generated from selling that unit. This situation leads to a loss of money on that additional production, which is against the firm's goal of maximizing profit. Instead, the firm should produce fewer units until the point where marginal cost equals marginal revenue, which will reduce its costs and increase its profit.

Step-by-step solution

Define Marginal Cost (MC)

Marginal cost is the additional cost that a firm incurs when it produces one more unit of its product. In other words, it is the increase in total cost resulting from a one-unit increase in production.

Define Marginal Revenue (MR)

Marginal revenue is the additional revenue that a firm receives when it sells one more unit of its product. In other words, it is the increase in total revenue resulting from a one-unit increase in sales.

Understand Profit Maximization

Profit maximization is the main goal of any firm. Profit is the difference between total revenue (TR) and total cost (TC). A firm aims to maximize profit by choosing the level of output that maximizes the difference between TR and TC. Mathematically, this can be represented as: \( Profit = TR - TC \)

Relationship between Marginal Revenue, Marginal Cost, and Profit Maximization

The profit-maximizing level of output is reached when the additional revenue generated from selling one more unit (MR) equals the additional cost incurred from producing one more unit (MC). In other words, a firm will maximize profit by producing at a level of output where: \(MR = MC\) By comparing the marginal revenue and marginal cost for each level of output, the firm can identify the profit-maximizing output level.

Explain Why a Profit-Maximizing Firm Will Not Choose to Produce at a Quantity Where MC > MR

If a firm decides to produce at a quantity where the marginal cost (MC) exceeds the marginal revenue (MR), it means that the additional cost of producing one more unit is greater than the additional revenue generated from selling that unit. In this situation, the firm is actually losing money on that additional unit of production. As the firm's goal is to maximize profit, producing at a level where MC > MR is not a profit-maximizing strategy. By producing fewer units until the point where MC = MR, the firm will reduce its costs and increase its profit. Therefore, a profit-maximizing firm will never choose to produce at a quantity where marginal cost exceeds marginal revenue.