This paper explores marginal analysis, a fundamental concept in microeconomics used by companies to make production and pricing decisions. It defines marginal revenue as the change in total revenue from selling one additional unit and marginal cost as the change in total cost from producing one additional unit. The paper explains two key approaches to profit maximization: the Total-Revenue–Total-Cost method and the Marginal-Revenue–Marginal-Cost method. It also distinguishes between accounting profit and economic profit, and provides guidance on adjusting output levels based on the relationship between marginal revenue and marginal cost to achieve optimal profitability.
The course textbook Economics defines marginal revenue as "the change in total revenue that results from selling one more unit of output" (McConnell, Brue, Flynn & et al, 2011, p. 166). For example, if each unit of the company's product sells for $10, there will be a marginal revenue of an additional $10 every time one more unit is sold. For each level of output, the company can find the total revenue by multiplying the unit price by the quantity produced.
When a company is considering whether to alter total product output, it will determine what the resulting change in total revenue will be. The company will compare the change in total revenue to the resulting change in total cost and choose the course of action that is most advantageous for its financial position.
Marginal cost is the change in cost a company incurs when one additional unit of the company's product is produced. For example, if each unit of the company's product costs $5 to produce, there will be a marginal cost of an additional $5 every time one more unit is produced. The method to determine marginal cost is to divide the change in total cost by the change in quantity produced.
When a company is considering whether to alter total product output, it will determine what the resulting change in total cost will be. The company will compare the change in total cost to the resulting change in total revenue and choose the course of action that is most advantageous for the company.
A basic definition of profit is the result when a company's total expenses are subtracted from its total revenue. However, this simple definition can be misleading and should be explained in two ways.
First, accounting profit is total revenue minus the explicit costs incurred. Accounting profit is reported on the company's taxes and is also used to determine if its financial obligations are being met. Second, economic profit is total revenue minus both explicit and implicit costs. The company uses economic profit to determine whether its current business venture is the best option for its available resources.
Profit maximization is a process by which a company can determine the output level that will provide optimal profit. One method that can be used is the Total-Revenue–Total-Cost approach. A chart is created listing the Total Costs (fixed and variable), the Total Revenue, and the Profit or Loss for each level of output. Profit or Loss is determined by subtracting Total Costs from Total Revenue. Once the chart is completed, it is simply a matter of identifying the output level that has the maximum profit.
A second method to identify the profit-maximizing output is the Marginal-Revenue–Marginal-Cost approach. The company will attain maximum profit when it produces product at an output level where the Marginal Revenue equals the Marginal Cost. A chart is created listing the Marginal Cost and Marginal Revenue for each level of output. Once the chart is complete, the company identifies the output level where Marginal Cost and Marginal Revenue are equal or most nearly equal. Note that the actual point of equality is usually a fraction, so the company should drop the fractional amount and produce at the last whole product level.
"Decision rules for adjusting production based on MR and MC"
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