Econ

Discuss how profit maximizing level of output in perfectly competitive firm is achieved. (5 marks)

Perfect competition is defined as a market structure in which there are many buyers and sellers , the product is standardized and sellers can easily enter or exit the market. 

It's characteristics are large number of sellers , selling homogenous product , free entry market and exit and perfect knowledge information for both sellers and buyers. 

Marginal revenue (MR) is the additional revenue from producing an additional unit of goods while marginal cost (MC) is the additional cost from producing an additional unit of goods. When MR exceeds MC, revenue is increasing faster than costs and the firm should increase production. When MR MC, revenue from the additional unit is less than additional cost, and the firm should decrease production.  As such, a firm maximizes profits when MR MC. 

MC

P

ATC

a

P1

P1=AR1=MR1

b

P2

0

q

q1

As all sellers are selling the same product in the market , none of them have the power of changing the price of goods and therefore , they are known as price taker. Hence , price level remains constant. From the profit maximisation diagram above , average total cost (ATC) intersects MC at its minimum point and is below the price. This is showing that the firm is earning a profit . The total revenue(TR) area (price x quantity) , P1 a q1 0 , is larger than the total cost(TC) area , P2 b q1 0. When TR TC there are showing that the firm is earn a profit. Firm earns an economic profit , P1 a b P2.