4.3.1. Condition 1

Profits are the difference between total revenue and total cost. Both total revenue and total cost increase as output increases. Notice that as long as the change in total revenue is greater than the change in total cost, profits will continue to increase. Recall that change in total revenue per unit increase in output is the marginal revenue; and the change in total cost per unit increase in output is the marginal cost.

In this chunk, we define profits as the difference between total revenue and total cost. As a firm increases its output, both total revenue and total costs may rise. However, if the additional revenue (marginal revenue) gained from selling one more unit is greater than the extra costs (marginal cost) incurred to produce that unit, then profits increase. Therefore, monitoring these changes helps a firm to decide how much to produce to maximize profit.

Think of a lemonade stand. If you sell one more cup of lemonade for $2 (marginal revenue), but it only costs you$1 to make that cup (marginal cost), you're making an extra dollar in profit. As long as you can keep selling more cups at that profit margin, you should continue increasing your production.

Therefore, we can conclude that as long as marginal revenue is greater than marginal cost, profits are increasing. By the same logic, as long as marginal revenue is less than marginal cost, profits will fall. It follows that for profits to be maximum, marginal revenue should equal marginal cost.

This chunk emphasizes the critical relationship between marginal revenue (MR) and marginal cost (MC). If MR is greater than MC, the firm can increase its profits by producing and selling more units. Conversely, if MR is less than MC, producing additional units would decrease profits. The optimal point for a firm occurs when MR equals MC, indicating that the firm is maximizing its profits – any further production would yield no additional profit.

Imagine you're playing a video game where you earn points for completing levels. If completing a level (producing a good) earns you more points than it costs in game resources (marginal cost), you will want to keep playing. However, if the cost becomes higher than the points you earn, you would stop playing that level. The balance point where you earn just as many points as you spend energy equals the best strategy for maximizing your points.

In other words, profits are maximum at the level of output (which we have called q₀) for which MR = MC. For the perfectly competitive firm, we have established that the MR = P. So the firm’s profit maximizing output becomes the level of output at which P = MC.

This segment ties the concept of profit maximization specifically to perfectly competitive markets. For firms operating in such markets, the marginal revenue is equivalent to the market price (P). Therefore, a firm's profit-maximizing level of output is found where the price equals the marginal cost (P = MC). This means that competitive firms will adjust their production to this point to ensure they are not leaving potential profits on the table.

Consider a farmer selling apples in a market flooded with many sellers. If the price of apples is set at $1 per apple (price equals marginal revenue), the farmer will want to harvest apples until the cost of picking one more apple (marginal cost) is equal to$1. If it costs $0.75 to pick an apple, he will keep picking because he’s earning more than he spends. The moment it costs$1 to pick, he stops because he’d be breaking even, which maximizes his profits at this market price.

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