Answer to Question 1
Because resources are scare, it is not possible to fulfill everyone's wants. As a result, some method of deciding which wants will be fulfilled and which will notthat is, some method of allocating resourcesmust be utilized.
Answer to Question 2
A firm can maximize profits by producing up to the point where the additional revenue earned from one extra unit is equal to the additional cost of each unit, i.e. at the point where marginal revenue is equal to marginal cost. For competitive firms, marginal revenue is equal to price, so these firms will maximize profits by producing at the point where price is equal to marginal cost.
There are two caveats to the price equal to marginal cost rule. First, in the short run the firm price must be at least as large as average variable cost; otherwise the firm will shut down. Second, in the long run price must be as least as large as average cost; otherwise the firm will exit.
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