Answer to Question #298718 in Microeconomics for Divu

Question

How does a competitive firm determine its profit-maximizing level of output? Explain

Answer 1

Perfectly competitive association has solely one essential selection to make—namely, what extent to produce. To apprehend why this is so, think about the fundamental definition of profit:

Profit=Total revenue−Total cost =(Price)(Quantity produced)−(Average cost)(Quantity produced)

Since a perfectly aggressive firm ought to take delivery of the fee for its output as determined by the product’s market demand and supply, it cannot pick the rate it charges. Rather, the perfectly competitive company can select to promote any quantity of output at exactly the identical price. This implies that the company faces a flawlessly elastic demand curve for its product: customers are willing to buy any variety of units of output from the association at the market price. When the perfectly aggressive company chooses what volume to produce, then this quantity—along with the fees prevailing in the market for output and inputs—will determine the firm’s complete revenue, whole costs, and ultimately, degree of profits.

I).Determining the Highest Profit by Comparing Total Revenue and Total Cost.

A flawlessly competitive company can sell as large a extent as it wishes, as lengthy as it accepts the prevailing market price. Total income is going to amplify as the company sells more, relying on the fee of the product and the number of units sold. If you expand the wide variety of devices offered at a given price, then total income will increase. If the price of the product increases for every unit sold, then total income additionally increases.

As an example of how a perfectly competitive association decides what extent to produce, reflect consideration on the case of a small farmer who produces raspberries and sells them frozen for $4 per pack. Sales of one pack of raspberries will convey in $4, two packs will be $8, three packs will be $12, and so on. If, for example, the charge of frozen raspberries doubles to $8 per pack, then sales of one pack of raspberries will be $8, two packs will be $16, three packs will be $24, and so on .At any given quantity, total income minus whole fee will equal profit. One way to decide the most profitable extent to produce is to see at what quantity complete revenue exceeds complete value by way of the biggest amount. A higher rate would imply that whole income would be greater for each and every quantity sold. Graphically, the whole income curve would be steeper, reflecting the greater price as the steeper slope. A decrease rate would flatten the complete revenue curve, meaning that whole revenue would be decrease for each and every quantity sold. What occurs if the charge drops low enough so that the complete income line is completely under the whole cost curve; that is, at every level of output, total expenses are higher than whole revenues? In this instance, the first-class the company can do is to go through losses. However, a profit-maximizing company will choose the quantity of output the place complete revenues come closest to complete costs and as a result the place the losses are smallest.

II).Comparing Marginal Revenue and Marginal Cost.

Using whole revenue and total cost, is not the solely approach to figuring out the profit maximizing level of output., We can use an choice approach which uses marginal income and marginal cost.

Firms often do no longer have the critical statistics they want to draw a entire complete price curve for all tiers of production. They can't be sure of what complete expenses would appear like if they, say, doubled manufacturing or reduce manufacturing in half, because they have now not tried it. Instead, companies experiment. They produce a barely increased or decrease volume and observe how it influences profits. In economic terms, this sensible approach to maximizing profits capacity examining how changes in production affect revenues and costs.

In the module on manufacturing and dosts, we introduced the thought of marginal cost—the change in whole cost from producing one more unit of output. Similarly, we can define marginal revenue as the trade in total income from promoting one extra unit of output. As noted before, a firm in ideal opposition faces a flawlessly elastic demand curve for its product—that is, the firm’s demand curve is a horizontal line drawn at the market price level. This additionally capacity that the firm’s marginal revenue curve is the equal as the firm’s demand curve. Every time a consumer demands one greater unit, the firm sells one more unit and income increases by exactly the equal amount equal to the market price. In this example, each and every time the company sells a pack of frozen raspberries, the firm’s revenue increases via $4,marginal income does no longer exchange as the association produces extra output. That is because the charge is determined by way of provide and demand and does not change as the farmer produces extra (keeping in mind that, due to the relative small measurement of each firm, growing their furnish has no influence on the total market supply where fee is determined).

Since a perfectly aggressive firm is a fee taker, it can sell whatever quantity it wishes at the market-determined price. Marginal cost, the cost per extra unit sold, is calculated by means of dividing the change in complete fee by using the alternate in quantity. The formula for marginal cost is:

marginal revenue =price

marginal revenue=$\frac{change in total revenue}{change in quantity}$

Unlike marginal revenue, ordinarily, marginal cost modifications as the association produces a increased extent of output. At first, marginal cost decreases with additional output, but then it will increase with additional output.

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