A firm currently produces 100 units, where marginal revenue is $20 and marginal cost is $15. What should it do to maximize profit?
AReduce output, since costs are rising
BHold output steady, since MR > MC already means it is profitable
CIncrease output, since each additional unit adds more revenue than cost
DSet output where marginal revenue equals zero
When MR > MC, producing one more unit adds more to revenue than to cost, so profit increases. The firm should expand until MR = MC. Option 3 (MR = 0) maximizes total revenue, not profit — a common confusion. Stopping at the current output leaves money on the table.
Question 2 True / False
A firm earning zero economic profit is failing to cover its costs and should consider shutting down.
TTrue
FFalse
Answer: False
Zero economic profit means total revenue exactly covers all costs including implicit (opportunity) costs — the owner's forgone salary, the return on capital that could have been invested elsewhere. The firm's accounting profit is actually positive. A zero-economic-profit firm is doing exactly as well as its next-best alternative, so there is no reason to exit.
Question 3 Short Answer
Explain why a firm that sets output to maximize total revenue is not necessarily maximizing profit.
Think about your answer, then reveal below.
Model answer: Revenue is maximized where MR = 0 (the last unit adds nothing to revenue). But profit = revenue - cost, so profit is maximized where MR = MC. As long as MC > 0, the firm sacrifices more in costs than it gains in revenue by pushing output to MR = 0. The only case where revenue-maximizing and profit-maximizing coincide is if MC = 0.
This misconception arises from ignoring costs. A firm could sell more units and earn more revenue while its costs rise even faster, shrinking profit. The MR = MC rule balances the marginal gain against the marginal cost, identifying the true optimum.