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microbook_3e-page111 - Eric Doviak Principles of...

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Eric Doviak Principles of Microeconomics Why does a Firm Maximize its Profit where Marginal Revenue equals Marginal Cost? If a firm is operating in a competitive industry, then its total revenue is simply equal to the market price times the quantity it produces, so we can depict Total Revenue as a linear function of output (a straight line) in the graph on the next page (i.e. pQ TR ). In the graph, I’ve assumed that the firm’s Total Cost is increasing at an increasing rate (due to diminishing marginal product of labor). Notice that if the firm produces a very low level of output (quantity produced), it will not be profitable. If it produces too much, its costs will once again exceed its revenues and it will not be profitable. Over the range of output where the firm’s total revenue exceeds its total cost, the firm is making positive profit (in the short-run anyway). The firm maximizes its profit in the middle of that range, but at what point specifically? In the range of output where the slope of the
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