Economics, 3rd Edition

Profit Maximization for a 

Competitive Firm

This figure shows the marginal cost curve 

(MC), the average total cost curve (ATC) 

and the average variable cost curve (AVC). 

It also shows the market price (P), which 

equals marginal revenue (MR) and average 

revenue (AR). At the quantity Q

1

, marginal 

revenue MR

1

 exceeds marginal cost MC

1

, 

so raising production increases profit. 

At the quantity Q

2

 marginal cost MC

2

 is 

above marginal revenue MR

2

, so reducing 

production increases profit. The profit 

maximizing quantity Q

MAX

 is found where 

the horizontal price line intersects the 

marginal cost curve.

P fit M

i i ti

FIGURE 6.7

Costs

and

revenue

The firm maximizes

profit by producing

the quantity at which

marginal costs equals

marginal revenue

MC

2

MC

ATC

AVC

P = AR = MR

MC

1

Q

1

Q

2

Q

MAX

Quantity

0

P = MR

1

= MR

2

Marginal Cost as the Competitive 

Firm’s Supply Curve

An increase in the price from P

1

 to P

2

 leads to an 

increase in the firm’s profit-maximizing quantity 

from Q

1

 to Q

2

. Because the marginal cost curve 

shows the quantity supplied by the firm at any given 

price, it is the firm’s supply curve.

M

i

l

C

t

th

FIGURE 6.8

Price

P

2

P

1

0

Q

1

Q

2

Quantity

MC

ATC

AVC

Figure 6.8 shows how a competitive firm responds to an increase in the price which may have been 

caused by a change in global market conditions. Remember that competitive firms are price takers and 

have to accept the market price for their product. Prices of commodities such as grain, metals, sugar, 

cotton, coffee, pork bellies, oil and so on are set by organized international markets and so the individual 

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CHAPTER 6  BACKGROUND TO SUPPLY: FIRMS IN COMPETITIVE MARKETS  157

firm has no power to influence price. When the price is P

1

, the firm produces quantity Q

1

, the quantity 

that equates marginal cost to the price. Assume that an outbreak of bovine spongiform encephalopathy 

(BSE) results in the need to slaughter a large proportion of dairy cattle and as a result there is a shortage 

of milk on the market. When the price rises to P

2

, the firm finds that marginal revenue is now higher than 

marginal cost at the previous level of output, so existing farmers look to increase production. The new 

profit-maximizing quantity is Q

2

, at which marginal cost equals the new higher price. In essence, because 

the firm’s marginal cost curve determines the quantity of the good the firm is willing to supply at any price, 

it is the competitive firm’s supply curve.