Questions: Profit Maximization and Output Decisions

Question 1

A firm currently produces 100 units, where MR = $5 and MC = $9. To maximize profit, the firm should:

• A. Increase output — MR is still positive, so the firm is still earning revenue
• B. Reduce output — the last unit added more to cost than to revenue
• C. Maintain current output — MR and MC are already close enough
• D. Shut down immediately — MR < MC means the firm is losing money

Answer: (B)

When MR < MC, producing the marginal unit costs more than it earns — it reduces profit. The firm should produce less until MR = MC. Option D is a serious misconception: MR < MC means the firm should cut back to the profit-maximizing quantity, not shut down. Shutdown depends on whether price covers average variable cost, not on the MR-MC comparison at a particular unit. Option A confuses positive MR with profit — having MR > 0 doesn't mean producing more is beneficial if MC > MR.

Question 2

A competitive firm and a monopolist each face the same cost curves. How do their profit-maximizing rules compare?

• A. Only the competitive firm uses MR = MC; monopolists maximize by setting price above MR
• B. Both use MR = MC, but MR equals price for the competitive firm and is less than price for the monopolist
• C. Both use MR = MC, and MR equals price for both since they face the same costs
• D. The monopolist maximizes profit at MC = 0, since it controls its own price

Answer: (B)

The MR = MC rule applies to all profit-maximizing firms regardless of market structure. The difference is what MR equals. For a competitive firm, price is fixed (it's a price taker), so each additional unit earns exactly the market price: MR = P. For a monopolist, selling more requires lowering the price on all units, so MR < P — the marginal revenue curve lies below the demand curve. Same rule, different MR values — which is why monopolists produce less and charge more than competitive markets.

Question 3

The MR = MC condition for profit maximization applies to firms in all market structures — competitive, monopolistic, and oligopolistic.

• T. True
• F. False

Answer: True

This is a universal principle of marginal reasoning: keep doing something as long as the marginal benefit exceeds the marginal cost, and stop when they are equal. The logic is identical for any profit-maximizing firm. What changes across market structures is the shape of the MR curve: flat (equal to price) for competitive firms, downward-sloping for monopolists. The condition MR = MC is the same; only the value of MR at the optimum differs.

Question 4

A firm producing where MR = MC is expected to be earning positive economic profit.

• T. True
• F. False

Answer: False

MR = MC identifies the profit-maximizing (or loss-minimizing) quantity — it says nothing about whether that profit is positive, zero, or negative. Profit equals (P − ATC) × Q. If P > ATC at the optimal quantity, profit is positive. If P = ATC, profit is zero. If P < ATC (but P > AVC), profit is negative and the firm is minimizing losses by operating. A firm can be at MR = MC while running at a loss — it is still better off producing at that quantity than at any other, but losses are possible.

Question 5

Why do firms maximize profit where MR = MC rather than where marginal revenue is highest or where marginal cost is lowest?

Model answer: Profit is total revenue minus total cost. Each additional unit produced adds MR to revenue and MC to cost. If MR > MC, producing the unit increases profit — so the firm should keep going. If MR < MC, the unit reduces profit — so the firm should produce less. Profit reaches its maximum exactly where MR = MC: the last unit produced adds exactly as much to revenue as it adds to cost, and producing one more would reduce profit. Neither the peak of MR nor the minimum of MC is the relevant target — what matters is the gap between them, and that gap is zero only at MR = MC.

Revenue is maximized where MR = 0 (stop when the last unit adds nothing to revenue), but that ignores costs. Cost is minimized where MC is at its minimum — but that ignores the revenue side. Profit integrates both, and the marginal condition MR = MC is the precise statement that the revenue gain and cost gain from the next unit are exactly balanced.