Profit Maximization Profit Curve
Total Curves
Marginal Curves

Three Views

This exhibit illustrates how it can be identified for a monopolistically competitive firm, such as that operated by Manny Mustard's House of Sandwich, a well-known monopolistically competitive supplier of Deluxe Club Sandwiches, a tasty luncheon treat enjoyed by many hungry Shady Valley residents. Manny is one of many firms that produce sandwiches and similar products, meaning he faces a relatively elastic negatively-sloped demand curve.

The top panel presents the profit curve. The middle panel presents total revenue and total cost curves. The bottom panel presents marginal revenue and marginal cost curves. In all three panels, Manny maximizes profit when producing 6 sandwiches.

• Profit: First, profit maximization can be illustrated with a direct evaluation of profit. If the profit curve is at its peak, then profit is maximized. In the top panel, the profit curve achieves its highest level at 6 sandwiches. At other output levels, profit is less.


• Total Revenue and Total Cost: Second, profit maximization can be identified by a comparison of total revenue and total cost. The quantity of output that achieves the greatest difference of total revenue over total cost is profit maximization. In the middle panel, the vertical gap between the total revenue and total cost curves is the greatest at 6 sandwiches. For smaller or larger output levels, the gap is either less or the total cost curve lies above the total revenue curve.


• Marginal Revenue and Marginal Cost: Third, profit maximization can be identified by a comparison of marginal revenue and marginal cost. If marginal revenue is equal to marginal cost, then profit cannot be increased by changing the level of production. Increasing production adds more to cost than revenue, meaning profit declines. Decreasing production subtracts more from revenue than from cost, meaning profit also declines. In the bottom panel, the marginal revenue and marginal cost curves intersect at 6 sandwiches. At larger or smaller output levels, marginal cost exceeds marginal revenue or marginal revenue exceeds marginal cost.

More on the Marginal View

First, consider the logic behind using marginals to identify profit maximization.

1. Marginal revenue indicates how much total revenue changes by producing one more or one less unit of output.


2. Marginal cost indicates how much total cost changes by producing one more or one less unit of output.


3. Profit increases if marginal revenue is greater than marginal cost and profit decreases if marginal revenue is less than marginal cost.


4. Profit neither increases nor decreases if marginal revenue is equal to marginal cost.


5. As such, the production level that equates marginal revenue and marginal cost is profit maximization.

Profit Maximization, The Marginal View

• Average Revenue: First up is the average revenue curve, which can be seen with a click of the [Average Revenue] button. Because Manny Mustard is a monopolistically competitive firm, this average revenue curve is also its negatively-sloped demand curve.


• Marginal Revenue: A click of the [Marginal Revenue] button reveals the green line labeled MR that depicts the marginal revenue Manny receives from sandwich production. Because Manny is a price maker, this marginal revenue curve is also a negatively-sloped line, and it lies beneath the average revenue (and demand) curve. However, because Manny's demand relatively elastic, these two curves are close together.


• Marginal Cost: A click of the [Marginal Cost] button reveals a red U-shaped curve labeled MC that represents the marginal cost Manny incurs in the production of sandwiches. The shape is based on increasing, then decreasing marginal returns.


• Profit Maximization: Profit is maximized at the quantity of output found at the intersection of the marginal revenue and marginal cost curves, which is 6 sandwiches. Click the [Profit Max] button to highlight this production level. This is the same profit-maximizing level identified using the total revenue and total cost curves and the profit curve.

• If marginal revenue is greater than marginal cost, as is the case for small quantities of output, then the firm can increase profit by increasing production. Extra production adds more to revenue than to cost, so profit increases.


• If marginal revenue is less than marginal cost, as is the case for large quantities of output, then the firm can increase profit by decreasing production. Reducing production reduces revenue less than it reduces cost, so profit increases.


• If marginal revenue is equal to marginal cost, then the firm cannot increase profit by producing more or less output. Profit is maximized.