Final answer:
A firm aiming to maximize profits will produce a quantity where the marginal cost equals the marginal revenue. For perfectly competitive firms, this condition also translates to where price equals marginal cost. Profits depend on the market price's relationship to the average cost.
Step-by-step explanation:
Any firm, whether competitive or not, desiring to maximize profits, will choose its quantity of production based on the rule that marginal cost equals marginal revenue. This is a fundamental principle in economics for profit maximization. When a perfectly competitive firm increases its quantity of output, its total revenue increases at a constant rate because it must accept the market price. Moreover, the profit or loss a firm makes depends on the market price in relation to the firm's average total cost at the profit-maximizing quantity of output. If the market price is higher than the average cost, the firm will earn profits. Conversely, if the market price is lower, the firm will incur losses.
A perfectly competitive firm is characterized by its ability to sell any amount of its product at a constant price because the demand for its product is perfectly elastic. Therefore, profit maximization occurs where the price (P), which is also the marginal revenue (MR) for a perfectly competitive firm, is equal to the marginal cost (MC). If this price is above the average cost curve, the firm makes profits; if it is equal to the average cost curve, the firm breaks even; and if it is below, the firm suffers losses.