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Chapter 12: Problem 3

Explain why it is true that for a firm in a perfectly competitive market, the profit-maximizing condition \(M R=M C\) is equivalent to the condition \(P=M C\).

Short Answer

Expert verified
The profit-maximizing condition MR=MC is equivalent to P=MC in a perfectly competitive market because such firms are price takers and sell their goods or services at a price determined by the market. Therefore, the marginal revenue, MR, that the firm gets from selling an additional unit is just the market price, P. Thus, when MR=MC, it also means that P=MC.

Step by step solution

01

- Understand Marginal Cost and Marginal Revenue

Marginal Cost (MC) is the cost of producing one more unit of a good. Marginal Revenue (MR) is the additional revenue that a firm receives from selling one more unit of a good. In the context of a perfectly competitive firm, it should continue producing where its extra cost of producing a unit equals the extra revenue from that unit, i.e., the condition MR=MC.
02

- Understand the Price in a perfectly competitive market

In a perfectly competitive market, firms are price takers, meaning that the market determines the price for a product or service. The firm has no influence on the price and must accept the prevailing market price.
03

- Understand equivalence of MR=MC and P=MC

In a perfectly competitive market, since the firms are price takers, the market price (P) equals the marginal cost (MC). A firm maximizes profit where MR=MC, but since the firm cannot influence the price and must sell at market price, the MR in this case is equivalent to the price. Therefore, MR=MC is equivalent to P=MC in a perfectly competitive market.

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Most popular questions from this chapter

Suppose that each of the following is true: (1) The laptop computer industry is perfectly competitive, and the firms that assemble laptops do not also make the displays or screens; (2) the laptop display industry is also perfectly competitive; and (3) because the demand for laptop displays is currently relatively small, firms in the laptop display industry have not been able to take advantage of all the economies of scale in laptop display production. Use a graph of the laptop computer market to illustrate the long-run effects on equilibrium price and quantity in the laptop computer market of a substantial and sustained increase in the demand for laptop computers. Use another graph to show the effect on the cost curves of a typical firm in the laptop computer industry. Briefly explain your graphs. Do your graphs indicate that the laptop computer industry is a constant-cost industry, an increasing-cost industry, or a decreasing-cost industry?

Why are consumers so powerful in a market system?

(Related to the Don't Let This Happen fo You on page 418 ) Explain whether you agree with the following remark: According to the model of perfectly competitive markets, the demand curve for wheat should be a horizontal line. But this can't be true: When the price of wheat rises, the quantity of wheat demanded falls, and when the price of wheat falls, the quantity of wheat demanded rises. Therefore, the demand curve for wheat is not a horizontal line.

The late Nobel Prize-winning economist George Stigler once wrote, "the most common and most important criticism of perfect competition ... [is] that it is unrealistic." If few firms sell identical products in markets where there are no barriers to entry, why do economists believe that the model of perfect competition is important?

Suppose you decide to open a copy store. You rent store space (signing a 1-year lease to do so), and you take out a loan at a local bank and use the money to purchase 10 copiers. Six months later, a large chain opens a copy store two blocks away from yours. As a result, the revenue you receive from your copy store, while sufficient to cover the wages of your employees and the costs of paper and utilities, doesn't cover all your rent and the interest and repayment costs on the loan you took out to purchase the copiers. Briefly explain whether you should continue operating your business.
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