At the positive level of output, where a firm's profit is maximized, the following conditions must hold.
(A) p = LRMC
(B) LRMC is non-decreasing at $q_0$
(C) p ≤ LRAC
(D) p ≥ min. LRAC
Choose the correct answer from the options given below:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → (A), (B) and (D) only
(A) p = LRMC. Correct. This is the fundamental condition for profit maximization in both the short run and long run for a perfectly competitive firm. A firm maximizes profit by producing at the output level where the marginal revenue (which equals price 'p' for a price-taking firm) equals marginal cost.
(B) LRMC is non-decreasing at $q_0$. Correct. This is the second-order condition for profit maximization. The LRMC curve should be rising (or at least non-decreasing) at the level of output q₀ for the firm to be at a maximum.
(C) p ≤ LRAC: Incorrect. This condition is not necessary for profit maximization. This condition relates to whether the firm should produce in the long run. If p<LRAC, the firm is incurring losses and, in the long run, it will exit the industry because it cannot cover its average costs. If p=LRAC, the firm is earning zero economic profit (breaking even), which is the normal profit in perfect competition. If p>LRAC, the firm is earning positive economic profit. In fact, to maximize profit, the firm should aim for p ≥ LRAC, in the long run.
(D) p ≥ min. LRAC. Correct. This is the long-run condition for a firm to stay in the industry. In the long run, if the price falls below the minimum long-run average cost, the firm will exit the market because it cannot even cover its average costs. If p≥minimum LRAC, the firm can at least cover its average costs (including normal profit) and choose to produce. This is a necessary condition for a firm to produce any positive output in the long run, especially at the equilibrium where firms enter and exit until price equals min LRAC.