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Define marginal revenue and marginal cost. Explain their relevance to the firm’s profit-maximizing decision.

Define marginal revenue and marginal cost. Explain their relevance to the firm’s profit-maximizing decision.

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Answer #1

Marginal revenue (MR) is defined as the change in revenue when the sales of the produced good is increased by one unit. Calculated by the slope of total revenue.

Marginal cost (MC) is defined as the increase in the cost if we produce one more unit of good. Calculated as slope of the total cost.

The profit maximizing condition hence is MC=MR.

We arrive at this condition as follows:

If MC<MR, then there is still scope for increasing the production as the revenue gained as a result of producing one more unit is exceeding the cost.

If MC>MR, then the production will have to be brought down, because for every additional unit produced, the cost is exceeding the revenue.

Refer to the graph below.

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