Economics · Ch 4 — The Theory of the Firm under Perfect Competition
Condition 1
Condition 1
Profit: The Driving Force
A firm's profit is simply the difference between what it earns (total revenue) and what it spends (total cost).
Profit = Total Revenue – Total Cost.
Both total revenue and total cost rise when the firm produces more output. The question is: which one rises faster? The answer determines whether profit is growing or shrinking.
The Logic of Marginal Comparison
As output increases by one unit, total revenue changes by the amount called marginal revenue (MR), and total cost changes by the amount called marginal cost (MC).
- If the extra revenue from that one unit (MR) is greater than the extra cost (MC), then producing that unit adds to profit. So profit increases.
- If MR is less than MC, producing that unit reduces profit. So profit falls.
This is a simple, powerful idea: keep producing as long as each additional unit brings in more than it costs. Stop when the next unit would cost more than it brings in.
The textbook uses the phrase "change in total revenue per unit increase in output" to define MR, and similarly for MC. This is the standard definition: MR = ΔTR/ΔQ and MC = ΔTC/ΔQ, where ΔQ = 1.
The Profit-Maximising Condition
From the logic above, profit stops rising and reaches its maximum exactly at the point where the extra revenue from the last unit equals the extra cost of that unit. That is:
This is the fundamental condition for profit maximisation for any firm, regardless of market structure. The output level at which this holds is called in the textbook.
A common mistake is to think that profit is maximised when MR > MC. That only tells you profit is still rising. The maximum occurs precisely when MR equals MC — not before, not after.
Special Case for a Perfectly Competitive Firm
In perfect competition, the firm is a price taker. It can sell any amount at the market price . Therefore, for this firm:
Every additional unit sold adds exactly the market price to total revenue. Substituting this into the general condition gives the specific rule for a perfectly competitive firm:
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