If a perfectly competitive firm can increase its profits by increasing its output, then that firm’s product’s _____________.
- ((a))
Price exceeds its marginal costs
- ((b))
Price exceeds its average total costs
- ((c))
Average variable costs exceed its average total costs
- ((d))
Fixed costs are zero
Show Answer
Price exceeds its marginal costs
The correct answer is Price exceeds its marginal costs. Key Points
In a perfectly competitive market, a firm maximizes its profit when its marginal cost (MC) equals the market price (P). If the price exceeds the marginal cost, the firm can increase its output to earn additional profit. This indicates that producing more units adds more to revenue than to costs. The marginal cost is the additional cost incurred to produce one more unit of a product. When P > MC, producing an additional unit generates profit. At equilibrium, when the firm is profit-maximizing, the price equals marginal cost (P = MC). If not, the firm adjusts its output to achieve this balance. In this scenario, the firm would not stop producing until P = MC. Therefore, if profits can still be increased by raising output, it implies that the price exceeds marginal cost.
Additional Information
Perfect Competition Characteristics:
A perfectly competitive market has a large number of buyers and sellers, and no single firm can influence the market price. All firms sell homogeneous products, and there is perfect information about prices and products. Firms can freely enter and exit the market without restrictions.
Marginal Cost:
Marginal cost is the change in total cost when an additional unit of output is produced. It plays a crucial role in determining the optimal level of output for firms in various market structures, including perfect competition.
Profit Maximization Rule:
In any market structure, a firm maximizes its profit where marginal revenue (MR) equals marginal cost (MC). In perfect competition, MR = Price because firms are price takers.
Other Options Explained:
Option 2: Price exceeding average total costs (ATC) indicates profit, but it does not guarantee that increasing output will increase profits. Option 3: Average variable costs cannot exceed average total costs, as ATC includes both variable and fixed costs. Option 4: Fixed costs being zero is irrelevant to this scenario, as fixed costs do not change with output.
Important Points
Price and Marginal Cost Relationship: In perfect competition, firms adjust their output levels to ensure that price equals marginal cost at equilibrium. Short-Run and Long-Run Adjustments: In the short run, firms might produce at a level where P > MC, but in the long run, adjustments ensure that P = MC and economic profits tend toward zero. Economic Implications: When firms produce where P = MC, resources are allocated efficiently, and consumer surplus is maximized.


