Association of Chartered Certified Accountants (ACCA) Certification Practice Test

At which point is a firm said to be maximizing profits in the short run?

1. When total revenue exceeds total cost

2. When average revenue is at its highest

3. When marginal cost equals average cost

4. When marginal cost equals marginal revenue

The correct answer is: When marginal cost equals marginal revenue

A firm is said to be maximizing profits in the short run when marginal cost equals marginal revenue. This condition is crucial for understanding how firms make production decisions. When a firm analyzes its production levels, it assesses the additional cost incurred from producing one more unit of output, which is the marginal cost. Conversely, marginal revenue is the additional revenue gained from selling that extra unit. Profit maximization occurs at the point where producing one more unit adds exactly as much revenue as it adds in costs, meaning the firm is neither losing money on that unit nor missing out on potential income by not producing it. At this point, any production beyond this level would mean that the marginal cost of production starts to exceed the marginal revenue, leading to a decrease in overall profit. Hence, the firm balances its output level effectively to ensure maximum profitability in the short run by adhering to the equilibrium of marginal cost and marginal revenue. This concept is pivotal in microeconomic theory and is foundational for managerial decision-making.