Question

In which of the following situations would a perfectly competitive firm increase its per-period total profits by reducing output?

1) When the marginal cost of production is greater than the marginal revenue
2) When the marginal cost of production is less than the marginal revenue
3) When the average cost of production is greater than the average revenue
4) When the average cost of production is less than the average revenue

Answer 1

In a perfectly competitive market, a firm should reduce output to increase profits when the cost of producing additional units (marginal cost) exceeds the revenue from sales (marginal revenue).

Step-by-step explanation:

A perfectly competitive firm would increase its per-period total profits by reducing output when the cost of producing an additional unit (marginal cost) exceeds the revenue that the unit brings in (marginal revenue).

Since firms in perfect competition face a market price equal to marginal revenue, reducing production when marginal costs exceed this price can prevent losses and increase profits. It's crucial for a perfectly competitive firm to produce where marginal revenue equals marginal cost to maximize profits.

When the average cost of production is lower than the average revenue, a perfectly competitive firm is already making a profit. The situation where the company should reduce output to increase profits would occur if producing additional units pushed the average cost above the market price they receive.