Marginal revenue is defined as the change in revenue influenced by a change in the quantity sold (McConnell & Brue, 2012). As discussed by McConnell & Brue (2012), the marginal revenue curve just like the demand curve is affected by factors like change in income, change in prices of substitutes and complements, and population change. Total revenue can be termed as the total consumer expenditure on a product. A firm may decide to increase the price of their product and sell less or reduce the price and sell more. Marginal revenue is hence the change in revenue caused by the number of goods sold.
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Marginal cost and its relationship with a total cost
According to McConnell & Brue (2012), the cost is the value of money used to produce a product. The marginal cost, therefore, changes in the total cost influenced by the cost of producing an extra unit of a particular good. As McConnell & Brue (2012) indicate, the total cost is the specific level of production for a particular product including the fixed and variable costs. They argue that an increase in the total production cost due to an increase in the total output is the marginal cost (McConnell & Brue, 2012). To bring a product in its useful form includes purchasing raw materials, use of machinery to produce the product, labor, and other inputs. The amount inclusive of all these costs represents the actual total cost of a product.
Profit and the concept of profit maximization
Profit is the financial benefit realized when the amount of revenue gained in a business activity surpasses the expenses incurred (McConnell & Brue, 2012). In simpler
terms, profit can be defined as money earned after accounting for all other expenses. Profit maximization is a process whereby firms determine the prices and output volumes that yield the greatest profit (McConnell & Brue, 2012). This may include minimizing the difference between marginal revenue and marginal cost (McConnell & Brue, 2012). Total profit is maximized when the marginal and revenue costs are at equilibrium.
Determining the optimum level of output using marginal revenue and marginal cost
McConnell & Brue (2012) argue that when the marginal revenue surpasses the marginal cost in a particular level of output, then marginal profit is positive. In this case, more goods should be produced. However, when the marginal revenue is less than the marginal cost, then it means marginal profit is negative hence production should be reduced (McConnell & Brue, 2012). Total profit increases when the marginal profit is positive and decreases when the total profit is negative (McConnell & Brue, 2012).
Actions taken when the marginal revenue is greater than the marginal cost
When the marginal revenue is greater than the marginal cost, it means the firm is making abnormal profits. Such cases mostly occur with monopolies. In such a situation, the firm may continue production since there are greater rewards. This means that the firm has maximized its profit and must continue production until it reaches a point of equilibrium.
Actions taken when the marginal revenue is less than the marginal cost
When the marginal revenue is less than marginal cost, it is advisable to reduce the quantity produced and raise the prices until demand and sales levels are equal (McConnell & Brue, 2012). Finding a way to reduce the marginal cost is another option to mitigate the issue of marginal cost surpassing the marginal revenue. However, the most effective way to deal with this situation is to identify the point at which the marginal revenue can exceed the marginal cost (McConnell & Brue, 2012). This enables the firm to device strategies to increase in order to raise the marginal revenue to equal the marginal cost.
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McConnell, C. R., & Brue, S. L., Flynn, S. (2012). Economics (19th ed). Boston, Irwin: McGraw-Hill.