Tom, a math major, examines Jane's economics class notes and observes that when price-taking firms earn economic profit, they do not seem to produce a quantity that minimizes their costs. Is he correct? Is there significance to this observation?

Answer 1

Tom is right, but he is forgetting the fact that the most important goal motivating a firm is profit maximization. In equilibrium, the firm does minimize cost, but in a dynamic situation when the demand for the firm's product increases, the firm will take advantage of that change in demand. To produce an output that maximizes profit, the firm may have to pay employees overtime and use more costly suppliers for raw materials. Costs might be minimized at a different output, but the new level of output is produced at a minimum cost for that output, the firm's goal of maximizing profit is achieved, and consumers who want to buy the added output also gain.