Profit maximisation

Profit = total revenue − total cost: π = TR − TC. A competitive firm maximises profit at the output where three conditions hold:

• Price = marginal cost (p = MC). If MR (= p) is more than MC, producing one more unit adds more to revenue than to cost, so profit rises with output. If MR is less than MC, cutting output raises profit. So the firm stops where they are equal.
• MC must be rising (non-decreasing) at that point. Where MC is falling, producing a little more would raise profit, so that point cannot be the best.
• In the short run, price must be at least minimum AVC. If it is lower, the firm loses less by shutting down: then it loses only its fixed cost. In the long run, price must be at least average cost (AC).

Example: price ₹20. The 7th unit costs 16 to make and the 8th costs 23. Producing the 7th adds to profit (20 > 16); the 8th would reduce it (23 > 20). So the firm produces 7 units.

On a diagram, profit is a rectangle: TR (price × output) minus TC (average cost × output).