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Chapter 12 / Profit Maximization

# 12.5 Profit Maximization for a Competitive Firm

When we defined the revenue function for a competitive firm, we said that its inverse demand function was simply $p(q) = p$, where $p$ is the market price that the firm takes as given.

Therefore the competitive firm’s profit maximization problem is

$\overbrace{\pi(q)}^\text{PROFIT} = \overbrace{p \times q}^\text{REVENUE} - \overbrace{c(q)}^\text{COST}$

its marginal profit is

$\pi^\prime(q) = \overbrace{p}^{MR} - \overbrace{c^\prime(q)}^{MC}$

and so its optimal quantity is found by setting $p = MC$. Note that this is really just a special case of $MR = MC$, since in this case the firm’s marginal revenue from each unit sold is just $p$. The diagram below shows the total and unit revenues and costs for the case where $p = 12$:

As you can see, the profit-maximizing point occurs at $q = 24$, at which point $p = MC = 12$. As with the case of a firm facing a downward-sloping inverse demand curve, the profit may be represented as the area $(AR - AC) \times q$.

Since a competitive firm’s optimal choice depends on the price, a critical question to ask is how the quantity the firm supplies responds to a change in the market price. This is the subject of our next chapter: the supply curve of the competitive firm.

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