The marginal analysis of the market is the incremental analysis of costs and benefits of producing one extra unit of output. While the marginal revenue determines the extra revenue earned by selling one extra unit of output, the marginal cost determines the additional cost incurred in producing one extra unit of output.

The firm in a perfect competition is a price taker but has the freedom to decide the level of output. Since the firms are guided by the profit motive, they would like to produce the level of output where the profit gets maximised. In the perfectly competitive market, the profit maximisation takes place at the level of output where the marginal revenue equals the marginal cost of production. Till the equality between the marginal revenue and the marginal cost is obtained, the firm would alter its level of production.

The marginal revenue curve in the perfect competition is equal to the average revenue or the price , as the demand curve that each firm faces is perfectly elastic in nature. So the level of output gets determined by the firm at the point where the marginal cost curve intersects the average revenue or the marginal revenue curve, from below. The profit or loss to the firm then gets ascertained by the difference between the average revenue and the average cost curves of the firms.

The firm in perfect competition continues to produce even when it is incurring losses, as long as the firm is able to cover up its average variable costs. When the output of the firm gets determined at a level where the average revenue or the marginal revenue is less than the average variable costs, the firm will then shut down its production, as then it will not be able to cover even the operational expenses of production.