Marginal cost and marginal revenue Essay

Both marginal revenue and marginal cost determine how the production of an additional unit in an enterprise contributes to the profit of the enterprise. Therefore, they both play an important role in calculating the point at which an organization maximizes its profit. Marginal cost is the amount of money that the enterprise incurs in producing an additional unit while it counterpart, marginal revenue, is the amount of money that the production of an additional unit brings into an enterprise.

Companies aim at producing at such an amount that the aforementioned two measurements are equal. This way, the enterprise is at the profit maximization point. “The relationship between these two economic concepts is important because an imbalance on either side can result in production inefficiencies” (Vitez, 2013, p. 1). Such imbalances indicate economies of scale.

Scenario

Total Revenue to Total Cost

In the scenario given for company A, the company maximizes its profit after producing the seventh and eighth additional widgets. This observation is based on total cost and total revenue alone because the difference between Company A’s total revenue and its total cost is the highest at the seventh and eighth additional widgets.

Marginal Revenue to Marginal Cost

Basing the profit maximization observation on marginal cost and its counterpart, marginal revenue, Company A maximizes its profit after the production of the seventh additional widget. This is because at this point, Company A’s marginal cost has the same value as the company’s marginal revenue.

Marginal Revenue Calculation

“Marginal revenue refers to the revenue that a company gains after producing one additional unit.” (Moffat, 2013, p. 3). In Company A’s scenario therefore, marginal revenue is calculated by taking the difference between the total revenue reached after producing an additional widget with the total revenue attained after producing the previous additional widget.

For instance, the marginal revenue for producing the third additional widget can be obtained by subtracting the total revenue reached after producing the third additional widget with the total revenue reached after producing the second additional widget. That is,

MR (3^rd widget) = TR (3 widgets) – TR (2 widgets) (Moffat, 2013)

Marginal Revenue Increases and Decreases

In Company A’s scenario, marginal revenue increases if the discount given for the n^th additional widget is less than the discount given for (n-1)^the additional widget. If the discount given for the 2^nd additional widget is less than that given for the 1^st additional widget, then the marginal revenue increases for the 2^nd additional widget.

In the same way, Company A’s marginal revenue for producing the n^th widget decreases if the discount offered on that widget is more than the discount offered on the (n-1)^th. Similarly, the marginal revenue for Company A remains constant if the discount given for the n^th additional widget is the same as that given for the (n-1)^th additional widget.

Marginal Cost Calculation

“Marginal costs are the costs that a company incurs in producing one additional unit of a good.” (Moffat, 2013, p. 4). In Company A’s scenario, marginal cost is calculated by taking the difference between the total cost incurred after producing an additional widget with the total cost incurred after producing the previous additional widget.

For instance, the marginal cost for producing the third additional widget can be obtained by subtracting the total cost incurred after producing the third additional widget with the total cost incurred after producing the second additional widget. That is,

MC (3^rd widget) = TC (3 widgets) – TC (2 widgets) (Moffat, 2013)

Marginal Cost Increases and Decreases

In Company A’s scenario, marginal cost for the n^th additional widget increases if Company A spends more money on equipment maintenance while getting the supplies for producing that particular additional widget than it does while getting supplies for the (n-1)^th additional widget.

If the money spent on equipment maintenance while getting supplies for producing the n^th widget is less than that spent while getting supplies for the (n-1)^th widget, then the marginal cost decreases. If the equipment maintenance cost for making the n^th widget is the same as that for making the (n-1)^th widget, then the marginal cost remains constant (Moffat, 2013).

Where Profit Maximization Occurs

Profit maximization for Company A occurs after the production of the seventh additional widget. The reason for this is that at that at the seventh additional widget, the marginal cost is the same as marginal revenue.

Marginal Revenue Greater Than Marginal Cost

If Company A determines that its MR is greater than its MC, it should continue producing additional widgets until it reaches its point of profit maximization. That is, the company should continue producing until the seventh additional unit.

Marginal Cost Greater Than Marginal Revenue

If Company A determines that its MC is greater than its MR, it should stop production of additional widgets immediately because this is a sign that the company has passed its point of profit maximization.

Reference List

Moffat, M. (2013). Marginal Revenue and Marginal Cost Practice Question. Web.

Vitez, O. (2013). What Is the Relationship Between Marginal Cost and Marginal Revenue?. Web.