This paper defines marginal revenue and explains its relationship with total revenue, defines marginal cost and explains its relationship with total cost. Also, it explains how a profit-maximizing firm determines its optimal level of output, using marginal revenue and marginal cost as criteria and etc.
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Define marginal revenue and explain its relationship with total revenue.
“Marginal revenue (MR) is the rate of change in total revenue with respect to quantity sold”. In other words marginal revenue is the additional revenue from a product earned by a producer through the production and sales of an extra unit of the product. Algebraically, marginal revenue is the difference between total revenue earned by producing and selling ‘n’ units of a product instead of ‘n-1’ units. Formula for calculating marginal revenue is
MR = ∆TR/∆Q
Marginal revenue is the addition to total revenue associated with a unit increase in output or sales. There is a direct relation between marginal revenue and total revenue. When marginal revenue is positive, total revenue increases and it falls when marginal revenue is negative.
B. Define marginal cost and explain its relationship with total cost.
“Marginal cost is the change in total cost associated with a unit change in quantity”. Marginal cost is thus the additional cost incurred by the producer in producing an additional unit of product. Marginal cost is thus a cost incured in addition to previous cost ie. cost of producing ‘n’ units of output inplace of ‘n-1’ units. Formula for calculating marginal cost is
MC = ∆TC/∆Q
Marginal cost is related to the average total cost in the short-run since a change in total cost is reflected in the total average cost. The total variable cost is got by summing up marginal cost. C. Define profit and explain the concept of profit maximization. “An economist measures a firm’s economic profit as the firm’s total revenue minus all the opportunity costs (explicit and implicit) of producing the goods and services sold” (Mankiw, 2011, p. 262). Profit is the reward received by an entrepreneur for the risk taken during the process of production or for alloting scarce resources for production. Profit maximization is a method used for determinig the quantity of output to be produced and price to be incurred by an entrepreneur so as to receive maximum profit. D. Explain how a profit-maximizing firm determines its optimal level of output, using marginal revenue and marginal cost as criteria. A profit-maximizing firm will determine its optimal level of output at the point where marginal revenue of the firm equals its marginal cost. At this point the firm receives maximum profit. E. Explain what action a profit-maximizing firm takes if marginal revenue is greater than marginal cost. If marginal revenue is greater than marginal cost, then a profit maximizing firm will increase production which will be followed by a movement from earlier point of marginal revenue to a new intersection point where marginal revenue equals marginal cost. This step is adopted by the firm as there is room for further revenue at the earlier stage. F. Explain what action a profit-maximizing firm takes if marginal revenue is less than marginal cost. In a situation where marginal cost of a profit-maximizing firm exceeds its marginal revenue, the firm will cut short its production up to a level where it will equalize its marginal cost to marginal revenue. At the earlier level the firm was incurring loss. Task 2: A. Define the following three terms 1. Elasticity of Demand: Elasticity of demand has various definitions. “The price elasticity of demand is a measure of the sensitivity of the quantity demanded of a good to the price of a good. ‘Price elasticity of demand’ is sometimes shortened to ‘elasticity of demand’” (Taylor & Weerapana, 2009, p. 93). 2. Cross-Price Elasticity (includes substitutes and complements): Cross-price elasticity is the degree of responsiveness to change in the price of a related commodity on the demand for a good. “
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(Micro and Macro Economics (marginal Revenue; Marginal Cost; Essay)
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