If a firm is producing an output ...?

Question

If a firm is producing an output level of 500 units per day and the selling price is $35 per unit and the marginal cost of the 500th unit is $32, should the firm produce more or less to maximize profits? Why? What rule are you using to arrive at your answer? Summarize that rule.

Answer 1

The metric that should drive the answer whether to produce more units is the expected cost of the next unit not the marginal cost of the last. With a marginal cost of $32 one should assume that the average cost is much more than $32. The average cost probably is more than the current sale price of $35. This means that the company is probably losing money at this production rate. The answer that is needed is whether to discontinue the product or not. If the average cost can not be driven lower the product probably should be discontinued.
I work in a capital intensive field and may have over estimated the size of the average cost. If the marginal cost is really larger than the average because the cost is increasing for larger production then the situation would be different than I have portrayed. This might be because the parts are being built by artisans and less capable artisans are being added to the workforce and it takes them longer to produce the parts. It might also be that the firm must pay a bonus(overtime?) to get it's workers to work longer. If the marginal cost is rising rather than diminishing with larger production rates then there is another factor that must be taken into account. Will the extra production be able to be sold at the same price or will availability create more demand or will the selling price diminish with the need to get additional items sold. Assuming price stability then the firm should make more products until the marginal cost reaches the selling price.

Answer 2

If the firm is a purely competitive firm the answer would be yes, continue expanding output to the point where MR(price under pure comp.) = MC. Why? Because the production of the 501st unit will add for to revenue(MR) than it will to costs (MC), thus the unit it "paying it's way" and contributing to profit. We are using the "balance the margins rule", which means that in determining the optimal amount of output with a given price, a producer wants to produce that level of output where MR is in balance with MC. Otherwise known as MR=MC rule. Should MC exceed MR, then the firm needs to reduce the level of output because the last unit produced was adding more to cost than it was adding to revenue, otherwise taking away from profit.