8.b. The Geometry of Profit-Maximization

 

 

Perfect competition arises when there are many firms selling a homogeneous good to many buyers with perfect information. Under perfect competition, a firm is a price taker of its good since none of the firms can individually influence the price of the good to be purchased or sold. As the objective of each perfectly competitive firm, they choose each of their output levels to maximize their profits. The key goal for a perfectly competitive firm in maximizing its profits is to calculate the optimal level of output at which its Marginal Cost (MC) = Market Price (P). As shown in the graph above, the profit maximization point is where MC intersects with MR or P. If the above competitive firm produces a quantity exceeding qo, then MR and Po would be less than MC, the firm would incur an economic loss on the marginal unit, so the firm could increase its profits by decreasing its output until it reaches qo. If the above competitive firm produces a quantity fewer than qo, then MR and Po would be greater than MC, the firm would incur profit, but not to its maximum. Therefore, the firm could increase its profits by increasing its output until it reaches qo.