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Marginal costs, Marginal revenues and Profit Maximization

 

Introduction

A).Explain profit maximization from the following approaches:

Profit maximization is a process or criteria by which a company determines the price and the output levels that returns or posts the greatest profit.

1).Total revenue to total cost

Profit is equivalent to Total revenues minus Total costs i.e. P = TR – TC The profit maximization output is the one that this difference reaches its maximum. In this case, it’s the difference between the TR and TC curves where the difference is the largest. Where MR = MC is the general rule for determining profit maximization which is applicable to any company.

Profit Maximization – TR and TC

          

           

 

2).Marginal revenue to marginal cost

For each unit sold, the marginal profit is equivalent to MR – MC i.e. marginal revenue minus marginal cost. Marginal profit is positive when the marginal revenue exceeds the marginal costs and its negative when the marginal cost exceeds the marginal revenue .

                      Marginal Revenues, Marginal Costs and the Profit

              

The graph above leads to the general conclusion that the MR is always lower than demand curve. At a certain quantity, at any given time, the demand curve shows the price which corresponds to that quantity. The point where the curve crosses the vertical line is the only place where the MR and the demand curve are equal.(Sullivan and Sheffrin, 2003).

B).Explain the calculation used to determine marginal revenue.

The revenue a firm gains in the production of additional or extra unit of a good. The marginal revenue of selling two items instead of one, MR (2 nditem) = TR (2items) – TR (1item)

The marginal revenues obtained in selling 2 items is 290 – 150 = 140

Quantity TR TC MR
 0 0 10
1 150 30
2 290 50 140
3 420 80 130
4 540 120 120
5 650 170 110
6 750 230 100
7 840 300 90
8 920 380 80
9 990 470 70
10 1050 570 60
11 1100 680 50
12 1141 800 41
13 1170 930 29
14 1190 1070 20
15 1200 1220 10

Item number 2 calculation of marginal revenue

MR (2 nditem) = TR (2items) – TR (1item)

= 290 – 150 = 140

Item number 3 calculation of marginal revenue

MR (3rd item) = TR (3 rditem) – TR (2 nditem)

= 420 – 290 = 130

Item number 4 calculation of marginal revenue

MR (4 thitem) = TR (4 thitem) – TR (3 rditem)

=   540   –    420   =    120.

Item number 5 calculation of marginal revenue

MR (5 thitem) = TR (4 thitem) – TR (3 rditem)

=   650 –   540   =   110

Item number 6 calculation of marginal revenue

MR (6 thitem) = TR (6 thitem) – TR (5 thitem)

=   750 –   650   =   100

The rest of the figures in the table have been obtained in the same way.

 

1).Discuss how marginal revenue increases, decreases, or remains constant in the given scenario.  The marginal revenue is increasing at a decreasing rate. As the total revenue, quantity and total costs increases the marginal revenue is 120. They decrease until they reach a point where any more increments lead to a negative MR.

Quantity TR TC MR
 0 0 10
1 150 30
2 290 50 140
3 420 80 130
4 540 120 120
5 650 170 110
6 750 230 100
7 840 300 90
8 920 380 80
9 990 470 70
10 1050 570 60
11 1100 680 50
12 1141 800 41
13 1170 930 29
14 1190 1070 20
15 1200 1220 10

                      Marginal Revenue

 

.

C).Explain the calculation used to determine marginal cost.

These are costs a firm incurs in the production one additional or extra unit of a good. The marginal cost of selling two items instead of one, MC (2 nditem) = TC (2items) – TC (1item)

The marginal cost obtained in selling 2 nd item is 50 – 30 = 20

Item number 2 calculation of marginal revenue

MC (2 nditem) = TC (2 nditem) – TC (1 stitem)

= 50 – 30 = 20

Quantity TR TC MC
  0 0 10
1 150 30
2 290 50 20
3 420 80 30
4 540 120 40
5 650 170 50
6 750 230 60
7 840 300 70
8 920 380 80
9 990 470 90
10 1050 570 100
11 1100 680 110
12 1141 800 120
13 1170 930 130
14 1190 1070 140
15 1200 1220 150

 

Item number 3 calculation of marginal Cost

MC (3rd item) = TC (3 rditem) – TC (2 nditem)

= 80 – 50 = 30

Item number 4 calculation of marginal cost

MC (4 thitem) = TC (4 thitem) – TC (3 rditem

=  120 – 80 = 40

The rest of the figures on the table above have been obtained in the same way.

(Sullivan and Sheffrin, 2003).

 

1).Discuss how marginal cost increases, decreases, or remains constant in the given scenario.

As the total revenue, quantity and total costs increases the marginal costs also increases at a constant rate. When the quantity is 4, TR is 540, TC 120 then the marginal cost is 40.

 

Quantity TR TC MC
0 0 10
1 150 30
2 290 50 20
3 420 80 30
4 540 120 40
5 650 170 50
6 750 230 60
7 840 300 70
8 920 380 80
9 990 470 90
10 1050 570 100
11 1100 680 110
12 1141 800 120
13 1170 930 130
14 1190 1070 140
15 1200 1220 150

                                                     

                                                      Marginal Costs

                

The marginal cost increases at an increasing trend.

D).Explain where profit-maximization occurs for company using the chart provided in the given scenario.

A company maximizes profit by concentrating its operations where the marginal revenue equals to the marginal costs. Any change in fixed costs has no real effect on the profit maximizing price or output. A company treats the short term fixed costs merely as sunk costs and literally continues to operate as before. The general rule is one that satisfies the equation MR = MC. This is the rule for profit maximization. Graphically, in an illustration of Total cost and Total revenue, a company maximizes all its profit at the point where the slopes of its Total cost line and Total revenue lines are the same or equal. It can also be shown by the marginal revenue and the marginal cost diagrams.   (Sullivan and Sheffrin, 2003)

Profit Maximization for Firm A

                           A

The profit maximization output is the one that this difference reaches its maximum. In this case, it’s the difference between the TR and TC curves where the difference is the largest. Where MR = MC is the general rule for determining profit maximization which is applicable to any company.

E).Explain what action should be taken in terms of adjusting output if its determined that marginal revenue is greater than marginal costs?

If MR>MC i.e. increasing output a single unit brings more additional or extra revenues than the cost to produce them then its only logical to produce the unit, because in producing one unit the company will enjoy more benefit than the added costs .

F).Explain what action should be taken in terms of adjusting output if its determined that marginal cost is greater than marginal revenue.

If MC>MR, the last unit to produce costs more than the additional revenue it earns then its only reasonable reduce or cut down production because its added production creates more costs than additional benefits.

References

Sullivan, A., Sheffrin, S. (2003). Economics: Principles in action. Upper Saddle River, New Jersey, Pearson Prentice Hall.

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