Final answer:
A firm maximizes profits or minimizes losses by producing at the quantity where marginal revenue equals marginal cost.
Step-by-step explanation:
A firm is in a profit-maximizing position when it produces at a level where the marginal revenue (MR) from the last unit produced is equal to its marginal cost (MC). This condition aligns with the core principle of profit maximization in a perfectly competitive market, which posits that firms reach their highest profit potential (or minimize losses) when total revenue surpasses total cost by the greatest margin.
If a firm continues to produce when marginal costs are higher than marginal revenues, it essentially reduces its profits because it costs more to produce each additional unit than the revenue it generates. Therefore, by producing where MR = MC, the firm ensures that no additional units are produced that would result in a loss.
If the market price, which is equal to MR for a perfectly competitive firm, is above the firm's average cost at the profit-maximizing output, the firm will realize an economic profit. Conversely, if the market price is below the average cost at this level of output, the firm will experience losses. However, due to fixed costs already incurred, the firm may continue producing in the short term to minimize those losses.
This results in the highest difference between total revenue and total costs, and the firm earns profits if the market price is above its average cost at this output level. Otherwise, the firm may incur losses but might keep producing to cover fixed costs.