Association of Chartered Certified Accountants (ACCA) Certification Practice Test

In a profit-maximizing position, what condition must be met?

1. Marginal revenue equals marginal cost

2. Total revenue equals total cost

3. Average revenue equals total cost

4. Price equals marginal cost

The correct answer is: Marginal revenue equals marginal cost

In a profit-maximizing position, the condition that must be met is that marginal revenue equals marginal cost. This principle is fundamental in microeconomics and is derived from the behavior of firms in competitive markets. When a firm is producing and selling goods, it generates revenue from those sales. Additionally, it incurs costs associated with producing additional units of goods. Marginal revenue is defined as the additional revenue obtained from selling one more unit of a product, while marginal cost is the increase in total cost that arises from the production of that additional unit. To maximize profit, the firm needs to ensure that the revenue gained from selling an extra unit (marginal revenue) is precisely equal to the cost incurred to produce that unit (marginal cost). If marginal revenue is greater than marginal cost, the firm can increase profits by producing more. Conversely, if marginal revenue is less than marginal cost, the firm is not maximizing profit, as it would actually be losing money on additional production. This equilibrium condition ensures that the firm is operating at an optimal output level, where no further profitable adjustments can be made without incurring losses. By adhering to this principle, a firm makes decisions that align closely with maximizing its profitability based on the current market conditions.