Sunday, April 29, 2007

Perfect Competition Review

I noticed that some people were confused as to why Q is the optimal level of output. Essentially any other output level (Q) is sub optimal. Why?
Well if the firm produces below Q (to the left) than you have a situation where MR>MC. That is, producing more units produces more marginal revenue than it does marginal costs. Hence the firm can increase its profits simply by producing more at the product price (P). If you look at the graph and draw a line up you will notice that the MR curve (the red line) is greater than the MC point (where the line cross the Nike Swoosh).
On the other hand, if you produce more units than the Q shown then MC>MR. Each extra unit produced costs more than the marginal revenue it is bringing in. Thus profits are decreasing if the firm starts producing more.
So in conclusion, there is no better point than Q (where MR=MC). That is where the firm is maximizing profits.
Note, however, that in perfect competition there is only normal profits. There are no economic profits because P=ATC. If you want permanent economic profits than P>ATC, you will most likely have to look at a monopoly model.

1 comment:

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