How Much Should the Firm Produce?
If a firm decides that, according to Rule 1, production is worth
undertaking, it must then decide how much to produce. The key to
understanding how much a profit-maximizing firm should produce is to
think about it on a unit-by-unit basis. If any unit of production adds more
to revenue than it does to cost, producing and selling that unit will
increase profits. According to the terminology introduced earlier, a unit of
production raises profits if the marginal revenue obtained from selling it
exceeds the marginal cost of producing it.
Now let’s consider a firm already producing some level of output and see
what happens if it increases or decreases its output. If an extra unit of
output will increase the firm’s revenues by more than it increases costs
the firm should expand its output. However, if the last unit
produced increases revenues by less than it increases costs
the profit-maximizing firm should reduce its output. From this logic we
get our profit-maximizing rule.
Rule 2: If it is worthwhile for the firm to produce at all, the profit-maximizing firm should
produce the output at which marginal revenue equals marginal cost. [ 23 ]The two rules that we have stated refer to each firm’s own costs and
revenues, and they apply to all profit-maximizing firms, whatever the
market structure in which they operate. However, we have already seen
(MR>MC),
(MR<M