Marginal Revenue Marginal Cost

Marginal revenue = marginal cost This paper will examine the MR=MC principle, which is one of the guiding economic principles for business. This reflects the relationship between marginal revenue and marginal cost. Marginal revenue is the additional revenue from producing a unit of a good, and marginal cost is the additional cost of producing that unit.

In general, businesses prefer to produce only when they can make more selling a unit than it cost to produce, but there are exceptions, and that is where the MR=MC principle relationship becomes interesting. MR=MC is also known as the profit maximization rule (IE, 2018). The slope of this curve reflects the margin, and how it changes as the company achieves economies of scale.

For example, if a company has a slow, manual process for producing widgets that results in a marginal cost of $1.00 per widget, and but because widgets are not differentiated even when made by hand, the marginal revenue at that production level is $0.75. This means the company cannot produce at that level profitably. If it invests in a machine that allows it to produce widgets for $0.25 per unit, and the marginal revenue remains the same, than this illustrates the value of producing at scale.

The MR=MC equation relates to the TR=TC equation. The profit a business earns is defined by the total revenue – total cost equation. The difference between that and the marginal is that total cost includes fixed costs. Fixed costs do not change in relation to the number of units produced, so they are not typically included in the marginal cost equation. But they do matter when determining firm profit. The relationship between marginal costs and fixed costs is when a firm seeks to define its breakeven point (Investopedia, 2018).

The breakeven point is the number of units that the firm needs to produce in order to be profitable. The relationship to marginal revenues and costs is fairly straightforward. In order to pay fixed costs, a firm needs to earn some sort of gross profit (MR-MC) from its goods. It needs to sell enough units in order to cover fixed costs, in order to be profitable. Marginal costs plus fixed costs = total costs. There are a few other points of significance from this graph.

Past the breakeven point - on this graph represented by Q, the company makes a total profit. Before this point, the company earns a total loss. In general, a firm should never sell a product for less than it costs to produce, otherwise it will lose more money the more units it sells. There are some exceptions, however. The simplest exception to the MR=MC rule is when a company has a high cost associated with exiting a business.

Even if the company is losing money on each unit produced, if the net loss in that situation is more favorable than the net loss associated with ending production, then the company would still have to produce. Thus, it depends on the structure of the fixed costs. If the fixed costs are strictly associated with a factory, and ending production will eliminate those costs, then the company has to sell when MR.