A question from Yahoo! Answers:
Why is a firm profit-maximising when MR=MC and not when MR>=MC?
My economics teacher has been repeatedly teaching us that the profit maximising point for firms is when marginal revenues equal marginal costs. Well, to maximise profit, wouldn’t the firm want MR to exceed MC, thus making an abnormal profit on each marginal unit?
There must be more to this than my understanding, unless my teacher is plain wrong…
OK, here is a (hopefully, comprehensible) graphical explanation:
After the company breaks even, TR usually increases faster than TC, so TR and TC begin to diverge. As q continues to increase, TC’s growth will pick up due to diminishing returns, while TR’s growth will start slowing down due to effects of diminishing marginal utility. So at some value of q (marked by the dashed line on the graph above), TR and TC will stop diverging and start converging. At that value, two things will happen:
- The two lines will be separated by the greatest vertical distance (after all, they just stopped diverging and they are about to start converging).
- The slopes of the two lines will be equal (while they were diverging, the slope of TR was greater than the slope of TC; as they start to converge, the slope of TC will become greater than the slope of TR)
Now, let’s recall that in economics, the vertical distance between TR and TC is called profit, the slope of TR is called MR, and the slope of TC is called MC. Make proper substitutions to the two statements above, and you will find that the profit is indeed maximized when MC=MR…