Marginal revenue and marginal cost
Total revenue to total cost
In the production of a product, every producer would like to maximize his profit accusation while minimizing the occurrence of loss (Mankiw, 2011). This will occur at the level of output whereby the producers can maximize the profit. The following graph is an illustration of the way in which the producers achieve profit maximization.
Any point between the break-even point represents the economic profit. On the graph, the profit maximization occurs at the point where the distance between the total revenue and total cost is longest (Mankiw, 2011). The point represents the region where the producers enjoy maximum economic profits. Consequently, the producer would continue producing at this point since there is profit maximization.
Marginal revenue to marginal cost
Marginal cost represents the change in the total cost when the output changes with one more unit while marginal revenue represent the change in total revenue when there is sale one more unit. Every business in the market acts as price taker hence any sale of an additional unit adds equal amount to the price to the total revenue (Mankiw, 2011). This means that the marginal revenue represents the price given by the horizontal demand curve. In the graph, marginal revenue is equal to the market price and it represents the horizontal line while the MC appears as J-shaped. The profit maximization occurs when the marginal revenue (MR) is equal to marginal cost (MC).
Calculation of marginal revenue and marginal cost
The calculation of marginal revenue involves determining the quotient between the change in total cost and the change in the output quantity (Mankiw, 2011).
MR = (Change in total revenue)/(change in output quantity)
Calculation of marginal revenue depends on the idea that the revenue resulting from producing a single unit is dependent of the total revenue that the involved firm produces. This means that any change (in terms of increase or decrease) will lead to the change in the marginal revenue. An increase in the total revenue will result in the increase of the marginal revenue and vice versa, when there is decrease.
Determining marginal cost would involve finding the quotient between the change in total cost and the change in quantity.
MC = change in TC / change in quantity
Calculation of marginal cost depends on the idea that the cost spent on producing a single unit is dependent of the total volume that the involved firm produces. The formula provides that an increase in the change in the total cost will lead to the increase in the marginal cost while the decrease in TC will lead to the decrease in MC (Mankiw, 2011). However, the marginal cost would remain constant if the total cost of the involved firm does not change.
Adjustments
Provided the marginal revenue is greater than the marginal cost, the involved firm should consider maximizing its production up to the point when the production of the last item is a break even. This means that the firm has maximized their production and profits. However, the opposite of this will be true when the marginal cost is greater than the marginal revenues (Mankiw, 2011). If a profit-maximizing company is showing more marginal revenue than marginal cost then the company should consider producing more units. In this situation, the firm will need to reduce their production up to the break-even unit of the last produced item.
Reference
Mankiw, N. G. (2011). Principles of economics. Mason, Ohio: Thomson South-Western.
