Competitive firm is producing the level of output which is maximizing the profit where marginal cost of the last unit produced (MC) is equal to the marginal revenue (price) from selling the unit

0

$62

$62

–

–

–

–

10

$90

$62

$28

$2.80

$40

$4.00

20

$110

$62

$48

$2.00

$80

$4.00

30

$126

$62

$64

$1.60

$120

$4.00

40

$144

$62

$82

$1.80

$160

$4.00

50

$166

$62

$104

$2.20

$200

$4.00

60

$192

$62

$130

$2.60

$240

$4.00

70

$224

$62

$162

$3.20

$280

$4.00

80

$264

$62

$202

$4.00

$320

$4.00

90

$324

$62

$262

$6.00

$360

$4.00

100

$404

$62

$342

$8.00

$400

$4.00

Table 1. Marginal Revenues and Marginal Costs at the Raspberry Farm

In this example, the marginal revenue and marginal cost curves cross at a price of $4 and a quantity of 80 produced. If the farmer started out producing at a level of 60, and then experimented with increasing production to 70, marginal revenues from the increase in production would exceed marginal costs—and so profits would rise. The farmer has an incentive to keep producing. From a level of 70 to 80, marginal cost and marginal revenue are equal so profit doesn’t change. If the farmer then experimented further with increasing production from 80 to 90, he would find that marginal costs from the increase in production are greater than marginal revenues, and so profits would decline.

The profit-maximizing 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. (In the example above, the profit maximizing output level is between 70 and 80 units of output, but the firm will not know they’ve maximized profit until they reach 80, where MR = MC.) Expanding production into the zone where MR < MC will only reduce economic profits. Because the marginal revenue received by a perfectly competitive firm is equal to the price P, so that P = MR, the profit-maximizing rule for a perfectly competitive firm can also be written as a recommendation to produce at the quantity where P = MC.