Why Does Marginal Revenue (MR) Equals Marginal Cost (MC) Equals Price (P) in a Perfectly Competitive Market?

You may have heard, seen and written the formula MR = MC = P countless occasions. But have you even wondered what's the logic behind this? Well, let me explain...

First of all we will glance through what MR, MC and P means. 

• MR - Marginal Revenue - additional revenue generated by selling one additional unit of a product
• MC - Marginal Cost - additional cost to produce one additional unit of product
• P - Price - price of the product, selling price

So how does the price of a product (P) equals marginal revenue(MR) of that product? Well, it's pretty simple...

MR = MC = P condition only occurs in a perfectly competitive market, meaning there are a large number of suppliers in the market and none of them are large enough to influence the market price. All they can do is sell their product at the prevailing market price.

So in a perfectly competitive market, the firms engage in high competition and ultimately drive the price to a very low level. This is so low that practically there is no profits in the sales price (P). Hence the product will be sold at the same price as the cost of producing the product (MC). Since the price is market given, the firms are unable to sell at a higher price either. So P = MC...

When the firm is producing the product at a specific cost, in a perfectly competitive market, they can only sell the product covering the cost of production. Since they cannot force a profit on the selling price, they will be forced to sell the product merely covering their production cost so that they can survive in the market. So any revenue generated by selling one unit of product (MR) will be more or less equal to the cost of producing the same unit (MC). Hence we can deduct that MR = MC.

Since P = MC and MR = MC, we can derive that P = MR = MC formula...

However this situation is unique to a perfect competition, which, in a real world is difficult to find. But the logic holds true.