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Essay on Economics
Setting marginal cost equal to revenue does not maximize profits. The key logical flaw in the theory of perfect competition can be seen more clearly if we first assume that the theory is correct—that the intersection of supply and demand does set market price, and that each firm produces where this price equals its marginal costs—and then seeing what happens if a single firm reduces its output. If economic theory is correct, this exercise should show that this firm reduces its profit, since the theory asserts that it is already producing at a point which maximizes its profit (Philip, 2002).
If, for whatever reason, a single firm reduces its output, then the market supply curve must move to the left—supply falls, however slightly. Since the market demand curve is assumed to be downward sloping, this causes a slight rise in the market price.
Because it has reduced its output slightly, it and all other firms in the industry benefit from an increased price. But there are three other forces acting in opposite directions on the individual firm's bottom line (Philip, 2002). Firstly, though its sale price has risen, its quantity sold has fallen—so its total revenue has probably fallen.....
