Question

In order to maximise profit, a firm should

a) increase output if MR < MC

b) reduce output if MR > MC

c) reduce output if MR < MC

d) both (a) and (b)

e) none of the above

Please EXPLAIN the solution by commenting on each and every choice as to why or why not is it correct/incorrect.

I tried doing this myself but I am very confused, hence, a detailed explanation is necessary. Thank you!

Answer 1

Correct option is (c).

When MR < MC, the firm is experiencing a marginal loss (= MC - MR), which will be minimized if output is reduced.

When MR > MC, the firm is experiencing a marginal profit (= MR - MC), which will be maximized if output is increased.

It is explained by following diagram. Profit is maximized at point A where MR intersects MC with price P0 and quantity Q0. If MR is less than MC (for example, at output level Q1), there is marginal loss which can be eliminated by decreasing output until the firm produces Q0.  If MR is higher than MC (for example, at output level Q2), there is marginal profit which can be maximized by increasing output until the firm produces Q0.