A firm is said to be in equilibrium at the output level where there is no incentive to alter output or supply decision e.g. at the profit-maximizing output level.
The general rule for profit-maximization is that the firm will achieve the maximum profit at the output level where Marginal Cost (MC) = Marginal Revenue (MR). Since in the case of a perfectly competitive firm, price and marginal revenue are equal, the profit-maximizing rule can be redefined as the point (i.e. output level) where MC = MR = P. It is also necessary that at that output level, MC is rising and the firm is incurring the least cost per unit i.e. Short-run Average Total Cost (SAC) of output.
As shown in Figure 10.1 below, the firm maximizes its profit by producing output Q1 where MC = MR = P. The firm’s total profit represented by shaded rectangle P1ABC is obtained as Total Revenue (rectangle P1OQ1C) less Total Cost (rectangle AOQ1B). Hence, the perfectly competitive firm is making a positive economic profit, otherwise referred to as abnormal profit or supernormal profit in the short-run.
Figure 10.1: The short-run profit-maximizing position for a perfectly competitive firm.