Marginal Revenue, Marginal Cost, and Profit Maximization

Marginal revenue (MR) is the additional revenue the firm realizes from the decision to increase output by one unit per time period.

MR = ΔTR/ΔQ.

In a perfectly competitive market, MR = P.

Under imperfect competition, MR < P.

[Practice Problems] The marketing director for a Swiss specialty equipment manufacturer estimates the firm can sell 200 units and earn total revenue of CHF500,000. However, if 250 units are sold, revenue will total CHF600,000. The marginal revenue per unit associated with marketing 250 units instead of 200 units is closest to:

A. CHF 2,000.    B. CHF 2,400.     C. CHF 2,500.

[Solutions] A

Marginal revenue per unit is defined as the change in total revenue divided by the change in quantity sold. MR = ΔTR ÷ ΔQ. In this case, change in total revenue equals CHF100,000, and change in total units sold equals 50.

CHF100,000 ÷ 50 = CHF2,000.

Marginal cost (MC) is the increase to total cost resulting from the firm’s decision to increase output by one additional unit per time period.

MC = ΔTC/ΔQ.

Short-run marginal cost (SMC) is the additional cost of the variable input, labor, that must be incurred to increase the level of output by one unit. SMC = w/MP_L.

Long-run marginal cost (LMC) is the additional cost of all inputs necessary to increase the level of output, allowing the firm the flexibility of changing both labor and capital inputs in a way that maximizes efficiency.

Variable costs are all costs that fluctuate with the level of production and sales.

Average variable cost (AVC) is the ratio of total variable cost to total output: AVC = TVC/Q.

AVC = w/AP_L

The profit-maximization decision for an operating firm as follows: Produce the level of output such that (1) MR = MC and (2) MC is not falling.