Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Firms are assumed to choose the output that makes economic profit (TR − TC) as large as possible.
- The change in profit from one more unit is MR − MC. If MR > MC, produce more; if MC > MR, produce less.
- So the profit-maximizing rule is: produce where MR = MC, on the rising part of MC.
- The rule gives the largest profit or the smallest loss. It does not promise a profit.
- A price-taking firm has MR = price. A firm that must cut its price to sell more has MR < price.
Key relationships
| Relationship | How to use it |
|---|---|
| Profit = TR − TC | total approach: pick the output with the biggest gap |
| MR = change in TR ÷ change in Q | for a price taker, MR = P |
| MC = change in TC ÷ change in Q | fixed cost drops out of every change |
| Change in profit = MR − MC | marginal approach: add units while this is ≥ 0 |
| Price of a price-setting firm | read from the demand (price) row at the chosen output, not from MR |
| Change | Profit-maximizing output |
|---|---|
| Fixed cost rises (rent, licence) | no change; profit falls by the same amount |
| Variable input cost rises (MC up) | falls |
| Market price rises (price taker: MR up) | rises |
Assumptions behind the model
- The firm’s goal is maximum economic profit (implicit costs included).
- The firm knows its revenue and costs at each output.
- Output is chosen for a given set of fixed inputs (the short run).
Mistakes to avoid
- Choosing the output with the highest profit per unit or the highest revenue.
- Using price instead of MR for a firm that must lower its price to sell more.
- Giving the price of a price-setting firm as the value of MR or MC at the crossing.
- Stopping at a crossing where MC is still falling.
- Saying a rise in fixed cost reduces output.
- Forgetting that MR = MC can give a loss.
Quick self-check
- A price taker sells at $20. The MC of its 9th unit is $18 and of its 10th is $23 (MC rising). How many units? (9: the 10th unit’s MC is above MR.)
- A firm sells 5 units at $40 each or 6 units at $37 each. What is the MR of the 6th unit? (6 × 37 − 5 × 40 = $222 − $200 = $22.)
- A firm’s yearly licence fee doubles. What happens to its profit-maximizing output? (Nothing: MC is unchanged. Profit falls.)
Next: practice questions.