Certified Management Accountant Practice Exam

Under what condition does a firm maximize profit?

1. When total revenue equals total cost

2. When marginal revenue equals marginal cost

3. When average costs are minimized

4. When there is no competition

The correct answer is: When marginal revenue equals marginal cost

A firm maximizes profit when marginal revenue equals marginal cost. This principle arises from the economic understanding of how firms operate in the market. Marginal revenue refers to the additional income generated from selling one more unit of a good or service, while marginal cost represents the additional expenditure incurred to produce that additional unit. When a firm is producing where these two measures are equal, it indicates that the company is neither gaining nor losing from producing one more unit; thus, profit is maximized. If marginal revenue were greater than marginal cost, producing additional units would increase overall profit, leading the firm to produce more. Conversely, if marginal revenue were less than marginal cost, the firm would be overproducing, which would decrease its profit margin. Hence, the equilibrium point at which marginal revenue equals marginal cost is essential for profit maximization in economic theory. The other options do not accurately describe profit maximization. Total revenue equaling total cost indicates a break-even point rather than profit maximization. Minimizing average costs can be important for profitability but does not inherently guarantee maximum profit. Lastly, the condition of having no competition may alter market dynamics but is not a requisite for profit maximization in terms of revenue and cost analytics.