Answer: If a competitive firm is producing where price (P) and marginal revenue (MR) are greater than marginal cost (MC) and average variable cost (AVC), it means that the firm is making a profit. In this situation, the firm has an incentive to increase its output level in the short run.
In a perfectly competitive market, the firm's price is equal to its marginal revenue, which is equal to its marginal cost. When P and MR are greater than MC and AVC, it means that the firm is earning positive economic profits. To maximize these profits, the firm will increase its output until the point where MC equals MR.
At this point, any further increase in output would result in a decrease in profit, as MC would be greater than MR. Therefore, the firm will choose an output level where P, MR, MC, and AVC are all equal, ensuring that the firm is maximizing its short-run profits.