Question

Briefly contrast when losses will be the smallest for a perfectly competitive firm based on total revenues with when losses for such a firm will be smallest based on marginal revenue.

Answer 1

Perfectly competitive firm is a price taker. As a perfectly competitive firm produces a greater quantity of output, its total revenue steadily increases at a constant rate determined by the given market price. Profits will be highest—or losses will be smallest—for a perfectly competitive firm at the quantity of output where total revenues exceed total costs by the greatest amount, or where total revenues fall short of total costs by the smallest amount.

The profit-maximizing (loss miniming) choice for a perfectly competitive firm will occur where marginal revenue is equal to marginal cost—that is, where MR = MC. A profit-seeking firm should keep expanding production as long as MR > MC. But at the level of output where MR = MC, the firm should recognize that it has achieved the highest possible level of economic profits.Expanding production into the zone where MR < MC will only reduce economic profits and generate losses. Because the marginal revenue received by a perfectly competitive firm is equal to the price P, so that P = MR, the profit-maximizing (loss miniming) rule for a perfectly competitive firm can also be written as a recommendation to produce at the quantity where P = MC.