Profit Maximization
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AP Microeconomics › Profit Maximization
Suppose a perfectly competitive firm produces 100 units of a good at its profit-maximizing quantity. If the market price is $$20$$, average total cost is $$15$$, and average variable cost is $$12$$, what is the firm's total economic profit?
$$2000$$
$$500$$
$$800$$
$$300$$
Explanation
Economic profit is calculated as (Price - Average Total Cost) * Quantity. In this case, profit per unit is $$20 - $$15 = $$5$$. Total economic profit is the profit per unit multiplied by the quantity, which is $$5 * 100 = $$\$500$$.
A firm's total revenue is maximized at a different quantity of output than its profit. This occurs because profit maximization considers
only marginal revenue, whereas revenue maximization focuses on average revenue.
only fixed costs, whereas revenue maximization considers only variable costs.
both revenue and costs, whereas revenue maximization considers only revenue.
only long-run outcomes, whereas revenue maximization focuses on the short run.
Explanation
Profit is defined as Total Revenue minus Total Cost. Therefore, to maximize profit, a firm must account for its costs of production. Revenue maximization, by contrast, only seeks the output level that generates the most sales revenue, ignoring the costs incurred to produce that output.
For a profit-maximizing perfectly competitive firm, productive efficiency is achieved when the firm produces at the quantity where
average total cost is minimized.
total revenue equals total cost.
price equals marginal cost.
marginal revenue equals price.
Explanation
Productive efficiency occurs when a good is produced at the lowest possible cost per unit. This is represented graphically as the minimum point on the average total cost (ATC) curve. While firms may not produce here in the short run, competition forces them to this point in long-run equilibrium.
The primary difference between a firm's short-run shutdown decision and its long-run exit decision is that the shutdown decision is based on
market demand, while the exit decision is based on the firm's supply curve.
whether price covers average variable cost, while the exit decision is based on whether price covers average total cost.
the level of economic profit, while the exit decision is based on the level of accounting profit.
total revenue and total cost, while the exit decision is based on marginal revenue and marginal cost.
Explanation
In the short run, a firm must pay its fixed costs regardless of production, so it will operate as long as price covers variable costs. In the long run, all costs are variable, so the firm will exit the industry if it cannot cover all of its costs, which are represented by the average total cost.
In a perfectly competitive market in long-run equilibrium, a typical firm will experience which of the following?
Zero economic profit and productive efficiency.
Positive economic profits and allocative inefficiency.
Negative economic profits and productive inefficiency.
Zero economic profit but allocative inefficiency.
Explanation
In long-run equilibrium, entry and exit of firms drive the market price to the minimum of the average total cost (ATC) curve. At this point, P = MC = min ATC. The condition P = min ATC ensures zero economic profit (a normal profit) and productive efficiency. The condition P = MC ensures allocative efficiency.
Assume a perfectly competitive firm is maximizing profit. An increase in the market demand for the good it sells will lead to an increase in the firm's
marginal revenue and quantity produced.
marginal cost curve and its supply.
total fixed cost and quantity produced.
average fixed cost but not its price.
Explanation
An increase in market demand will increase the market price. For a perfectly competitive firm, price equals marginal revenue. Facing a higher marginal revenue, the firm will increase its quantity produced to the new point where P = MC, thus maximizing its profit at a higher level of output.
If a perfectly competitive firm is earning positive economic profits in the short run, which of the following must be true at its profit-maximizing quantity?
Marginal cost is at its minimum point.
Price is equal to average total cost.
Price is greater than average total cost.
Price is less than average total cost but greater than average variable cost.
Explanation
Positive economic profit occurs when total revenue exceeds total economic cost. On a per-unit basis, this means the price (average revenue) must be greater than the average total cost at the profit-maximizing level of output.
A firm in any market structure will maximize its profits by producing the quantity of output at which
average total cost is minimized.
total revenue is maximized.
marginal revenue equals marginal cost.
price equals average total cost.
Explanation
The universal rule for profit maximization is to produce at the quantity where the revenue from the last unit sold (marginal revenue) is equal to the cost of producing that last unit (marginal cost). Producing more would mean MC > MR, reducing profit, while producing less would mean MR > MC, forgoing potential profit.
For a perfectly competitive firm, the profit-maximization rule of producing where marginal revenue equals marginal cost can also be stated as producing where
price equals average total cost.
total revenue equals total cost.
price equals average variable cost.
price equals marginal cost.
Explanation
In a perfectly competitive market, firms are price takers, meaning they face a perfectly elastic demand curve at the market price. Therefore, the price (P) is equal to the marginal revenue (MR) for every unit sold. Substituting P for MR in the general profit-maximization rule (MR = MC) gives P = MC.
A perfectly competitive firm is producing at a quantity where the market price is $$10$$, its marginal cost is $$8$$, and its average total cost is $$9$$. To maximize profit, this firm should
maintain its current output.
decrease its output.
increase its output.
shut down production immediately.
Explanation
The firm's marginal revenue is the market price of $$10$$. Since marginal revenue ($$10$$) is greater than marginal cost ($$8$$), the firm can increase its profit by producing and selling more units. It should continue to increase output until marginal cost rises to equal the market price.