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Profit Maximization in Perfect Competition

Question

Explain how a firm maximises its profit in perfect competition.

Category:

Market Structures and Competition

[CIE A level November 2019]

Preview Answer


Step ➊: Define ‘perfect competition’ and ‘profit maximisation’ the introduction.

Perfect competition is an ideal market structure that has many buyers and sellers, identical or homogeneous products, no barriers to entry. The main aim of perfectly competitive firms is to maximise profit. This can be achieved by producing at the profit maximising output where marginal revenue is equal to marginal cost as explained below.


Step ➋ : Explain how perfectly competitive firms maximise profit


➤ 2.1 Firms will produce where MR=MC in perfectly competitive firms.

It is assumed that perfectly competitive firms will seek to maximise their profits. They will aim to maximise the difference between the total revenue and total cost. A perfectly competitive firm will thus produce at the profit maximising output where marginal revenue is equal to marginal cost ( MR=MC ). This means that the firm produces up to the point where the cost of making the last unit is just covered by the revenue from selling it.

➤ 2.2 In perfectly competitive markets, D = AR = MR

It should be noted that perfectly competitive firms are price takers and will sell only at the ruling price P. If the firm sells an additional unit of output, it will get the same price as the one before. Thus marginal revenue is equal to the price or the average revenue (D = AR = MR ).

The perfectly competitive firm will operate at output Q where MC= MR both in the short run and the long run. This is shown in figure A and figure B.

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