One of the most important objectives of any business is profit maximization. The concept aids in the survival of the business, guarantees an increase in the return of its shareholders, and also prevents insolvency from occurring. In order for a business to understand profit maximization it must first comprehend the relationship between marginal revenue and cost.
For a company to properly understand marginal revenue and cost, it would have to determine how it is related to total revenue (TR) and total cost (TC). The TR is the total amount of money that a firm gets from, selling their products; the calculation to determine total revenue is TR=price X quantity. Total revenue is not considered profit though. Profit is actually total revenue minus total cost (profit=TR-TC). According to the scenario of the chart below, Company A increases ...view middle of the document...
Marginal revenue to Marginal Cost is equal; MR=MC. Marginal revenue is the change in extra funds from increasing quantity of widgets by one unit, which can be determined by the difference in the total revenue by dividing it by the change in quantities of widgets (MR = ΔTR (difference of two revenues at the same output level)/Δq (will always equal 1)) For example, the total revenue for producing 2 widgets is $290.00 is 140. “Marginal cost is the extra costs incurred in order to produce one more unit or product (McConnell, 2012, p. 150).” A company cannot determine the marginal costs unless if the total costs are available. When adding fixed costs and variable costs the end result is total costs. From there the marginal cost is found by dividing the change in total cost and quantity (McConnell, 2012, p.148).” In accordance with the given scenario of Company A, the marginal cost of 3 units of output is 30; MC= ΔTC/q (30= (80-50)/1). The scenario shows marginal costs increasing. As the demand for more widgets increases the company wants to produce more, therefore new investments, such as labor and equipment, are needed for the additional production.
If the marginal revenue for Company A was greater than the marginal cost, the firm should increase their production. Also if the company’s costs were greater than the revenue, then the firm should decrease production or stop making the product because further production activity is at a loss. Ultimately the ideal profit maximizing goal for any firm is if the revenue and the cost were the same. Therefore, it is pertinent for all who are involved in a business should understand the concept of profit maximization. Especially if the firm desires to maximize their profits at the highest level of output to guarantee survival.
McConnell, C. R., Brue, S. L., Flynn, S. M. (2012). Economics, 19th Edition
(pg. 164-181). New York, NY: McGraw-Hill/Irwin.