Throughout the course of this assignment, the relationship between marginal revenue and marginal cost will be explained and the importance of these concepts for profit maximization will be outlined. The total revenue to total cost and marginal revenue to marginal cost approaches will be described and the nature of Company A’s marginal revenue and marginal cost will be established. Attention will be paid to describing where profit-maximization occurs for the company and explaining the action that should be taken with regards to adjusting output if the marginal revenue is determined to be greater than the marginal cost and the action that should be taken if the marginal cost is determined to be greater than the marginal revenue.
‘Profit’ is the amount of value remaining after subtracting expenses that a company incurs throughout the course of the year from the quantity of revenue that it produces (Cromwell). ‘Profit maximization’ simply means taking steps to ensure that it is as high as possible. The total revenue to total cost approach involves working out what the profit-maximizing quantity is by subtracting total cost from total revenue for every possible quantity. The highest number represents the greatest profit. The marginal revenue to marginal cost approach works on the principle that companies can continue to expand their levels of output for as long as an additional output unit contributes more to revenue than it does to cost. It focuses on finding the point at which this is no longer the case. Marginal revenue can be determined by using the following formula:
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"Marginal Revenue And Marginal Cost".
Marginal revenue = Δ total revenue / Δ total output
The marginal revenue in the given scenario declines at an even rate through to the fifteenth output level.
Marginal cost can be determined by using the following formula:
Marginal cost = Δ total cost / Δ total output (Graham, 2013).
In the given scenario, the marginal cost remains at a constant until the second output level and then increases at an even rate through to the fifteenth output level. Profit maximization occurs at the eighth output level. Beyond this point, the marginal cost is greater than the marginal revenue. In situations where this is the case, the output should be reduced because it is costing more to produce a product than the company is capable of earning by producing it, meaning that it is no longer profitable. When the marginal revenue is greater than the marginal cost, the level of output can be increased in order to generate a higher degree of profit.
It is important to possess a strong knowledge of the relationship between marginal revenue and marginal cost in order to find the point at which the business will be at its most profitable. Failure to adequately locate this point can result in a company either failing to earn as much money as it is capable of generating or losing money on each product that it creates, which negates the purpose of the business existing. Working out the correct output level can ensure that the company reaches its full potential and manages to get to a stage where it is able to be as profitable as it can be.
In conclusion, it is essential for companies to calculate both the marginal revenue and marginal cost and spend time analyzing the relationship between them. In the case of Company A, the business reaches a point when the marginal cost exceeds the marginal value, meaning that it should have stopped producing output prior to this stage. The fact that this has been deduced means that action can be taken to reduce the output and ensure that profit is maximized. This demonstrates the practical application of working out these values and using them to determine the optimum output level for a business.
- Cromwell, J. The Difference Between Profit & Revenue Maximization. Houston Chronicle. Retrieved from http://smallbusiness.chron.com/difference-between-profit-revenue-maximization-23290.html
- Graham, R. (2013). Managerial Economics for Dummies. New York, NY: John Wiley & Sons.
