Why is the equality of marginal revenue and marginal cost essential for profit maximization
Why is the equality of marginal revenue and marginal cost essential for profit maximization in all market structures? Explain why price can be substituted for marginal revenue in the MR = MC rule when an industry is purely competitive. LO10.5
Marginal cost is the additional revenue earned from the sales of an extra unit of output and marginal cost is the additional cost inquired for the production of extra output. In the short run, if marginal revenue from selling an extra unit is more than marginal cost, the firm is earning more profit which means it is maximizing its profits. On the other hand, if the cost of producing an extra unit is more than selling an extra unit, the firm is making losses. Therefore, if there is equality between marginal cost and marginal revenue, profits would never decrease nor would it increase. Thus, it would be at its optimal level.
It is assumed that in pure competition demand is considered to be perfectly elastic which means that no matter what quantity is being demanded price of the good remains the same. Therefore, revenue earned from selling an extra unit of output remains the same and thus marginal revenue is equal to the price. Consequently, it can be used in the place of marginal cost.
When marginal cost is equal to marginal revenue it neither reduce cost nor increase profits thus, it is most efficient point of producing output. When pure competition exists price is considered to be constant and equal to marginal revenue because demand is perfectly elastic in purely competitive market structure.
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