Marginal Analysis, Essay Example

Introduction

This paper explains the relationship between that of marginal revenue and marginal cost in the context of economics.  In addition, the importance of these concepts from the perspective of profit maximization.

Marginal revenue

The revenue that a company generates over what it previously generated for each additional unit of output. For example, suppose a company generates $1000 in revenue from 100 units of a product (in other words $10 per unit). In order to sell 101 units it may have to reduce its price to $9.99 per unit. In this case, its revenue becomes $1008.99. Thus, the marginal revenue is $8.99.  (Harvey, 2004)

R= Revenue (price x quantity sold)    :   Q = Quantity Sold

From the demand curve it is possible to obtain Total Revenue. From this marginal revenue is ascertained being the additional revenue added by an additional unit produced.  Total Revenue is the area that sits under the demand curve as depicted in Fig 1.

When you determine marginal revenue you can determine what will happen to Total Revenue if the sales change. Hence where selling another unit increases total revenue, the marginal revenue must then be greater than zero.

Marginal cost

The total cost to a company to produce one more unit of a product. The marginal cost varies according to how many more or fewer units a company wishes to produce. Increasing production may increase or decrease the marginal cost, because the marginal cost includes all costs such as labour, materials, and the cost of infrastructure (Harvey, 2004)..  “Marginal cost and average cost can differ greatly.  For example, suppose it costs $1000 to produce 100 units and $1020 to produce 101 units.  The average cost per unit is $10, but the marginal cost of the 101st unit is $20” (EconModel, 2010).

The formula for Marginal Cost is:

MC= Marginal Cost

Q= Quantity

C=Cost

Hence marginal cost may be considered as the cost incurred when producing an additional unit of a product. The contrasted and compared to the total cost of that product. You can therefore determine that the average total cost will be the total cost of production at an activity level i.e. Total Cost / Total Production.

The illustration to the right shows an example of Marginal Cost in the Supply curve.

Profit

Profit may be defined as “The positive gain from an investment or business operation after subtracting for all expenses. Opposite of loss.”  (InvestorWorld).  Profit maximisation may be defined as “A process that companies undergo to determine the best output and price levels in order to maximize its return. The company will usually adjust influential factors such as production costs, sale prices, and output levels as a way of reaching its profit goal.”  (InvestorWorld).

In order to obtain optimum profit maximization output, you commence by recognising that profit is equal to Total Revenue (TR) less the Total Cost (TC).  You are then in a position to plot these figures graphically (Fig 5 refers).  The profit curve meets its’ maximum at Point A. Then at point B it can be observed the total cost curve is parallel to the Total Revenue (TR) curve.

In a situation where the marginal revenue exceeds that of the marginal cost, for a particular level of output, you can increase profit by increasing the level of output.  This until Marginal Revenue = Marginal Cost and at that point the output would need to be cut back. “If marginal revenue equals marginal cost, then the firm produces the profit-maximizing output quantity. If marginal revenue is less than marginal cost, then it can boost profit by increasing production.”  (AmosWeb).

The marginal cost equation

References

AmosWeb. (n.d.). Marginal Cost: . Retrieved 8 9, 2010, from AmosWeb: http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=marginal+cost

EconModel. (2010). Marginal Cost (MC). Retrieved 8 10, 2010, from EconModel: http://www.econmodel.com/classic/terms/mc.htm

InvestorWorld. (n.d.). Profit Definition . Retrieved 8 9, 2010, from InvestorWorld: http://www.investorwords.com/3880/profit.html