Perfect competition Activities  1
Competitive firm and profit maximisation:  Marginal revenue and marginal cost

The marginal revenue (MR) of a firm in a perfectly competitive market  is equal to the market price (P) of the product.  The profit-maximising rule can therefore also be stated as P= MC since MR = P. 

Marginal cost is U-shaped but only the rising part of MC is relevant for determining the quantity at which profits are maximised.

In the figure, profits are maximised at point a where MR = P = MC and the quantity at which profits are maximised is Q4.

 

The following numerical example illustrates why profits are maximised when MR (or P) is equal to MC.  The market price for the product is R10 per unit and is given in column 2.  The fixed cost is equal to R5 and is part of the total cost in column 4.  Total cost is equal to fixed costs plus variable costs.   Total profit (column 5) is equal to total revenue (column 3) minus total cost.  The change in profit (column 6) is equal to marginal revenue (column 7) minus marginal cost (column 8) (or it is the total profits of n units minus the total profit on n-1 units).

Quantity 
(units)
Q
Price per unit
(R)
Total revenue
(R)
Total cost
(R)
Total profit
(R)
Change in profits
(R)
Marginal revenue
(R)
Marginal cost
(R)
0 10 0 5 -5   10 -
1 10 10 9 1 10 4
2 10 20 15 5 10 6
3 10 30 23 7 10 8
4 10 40 33 7 10 10
5 10 50 45 5 10 12

As long as marginal revenue (MR) exceeds marginal cost (MC) a positive contribution is made to profit  and it is in the interest of the firm to expand production until the point is reached where MR = MC.  For instance the third unit adds R2 to total profits while the fifth unit causes a decrease in total profit. It is therefore not in the interest of the firm to increase production beyond four units.