MARGINAL ANALYSIS
MARGINAL REVENUE
Marginal revenue refers to the change in the total revenue resulting from an increase in the produced quantity by one unit. This is the revenue from producing one extra unit of a good.
RELATIONSHIP BETWEEN THE MARGINAL REVENUE WITH THE TOTAL REVENUE
In Maths, a marginal revenue function may be expressed as the first derivative of a total revenue (TR) function in respect to the quantity produced, Q. the marginal revenue can change with respect to volume or quantity, and therefore at every output level, our marginal revenue is the next produced units revenue.
MR change in TRchange in Q
MARGINAL COST
Marginal cost refers to the change in total cost arising from an increase in produced quantity by one unit. This is the cost pertaining to the production of one extra unit of a commodity.
RELATIONSHIP BETWEEN MARGINAL COST WITH TOTAL COST
In Maths, a marginal cost (MC) function may be expressed as the first derivative for the total cost (TC) function in respect to the Quantity (Q). The marginal cost can change with respect to the volume or quantity, and hence at every output level, our marginal cost is the next produced units cost.
MC change in TCchange in Q
PROFIT
Profit is the actual gain or benefit from production. Production costs are deducted from the sales figure to get the profit. It refers to the return to the entrepreneur from the input production factors.
THE CONCEPT OF PROFIT MAXIMIZATION
This is the process of determining the price, that is the selling amount and output quantity, which returns the huge or greatest profit. In marginal analysis, profit is said to be maximized at the point where the marginal cost equals the marginal revenue. Production beyond this point leads to a deduction in the total returns and the firm will not be maximizing returns to the factors of production.
HOW A PROFIT MAXIMIZING FIRM DETERMINES ITS OPTIMAL LEVEL OF OUTPUT USING MARGINAL REVENUE AND MARGINAL COST AS A CRITERIA
For every unit of sale, marginal profit will be equal to the marginal cost deducted from the marginal revenue. The optimal level of output will be at the point where marginal revenue is exactly equal to the marginal cost. This is because total profit will increase at the point with a positive marginal profit and it will start decreasing when marginal profit turns negative.
THE ACTIONS A PROFIT MAXIMIZING FIRM TAKES IF MARGINAL REVENUE IS GREATER THAN MARGINAL COST
Incase the marginal revenue is greater than the marginal cost, then marginal profit will be positive. At the point where marginal revenue is exactly equal to the marginal cost, at this stage marginal profit will be zero, by the marginal revenue being greater than the marginal cost, the profit maximizing firm will be incurring a marginal profit that is positive. It should therefore keep on producing extra units because this leads to an increase in the total profits. They however increase production till the marginal revenue equals the marginal cost.
THE ACTION A PROFIT MAXIMIZING FIRM TAKES IF MARGINAL REVENUE IS LESS THAN MARGINAL COST
Incase the marginal revenue is less than the marginal cost, then marginal profit will be negative. The firm will have gained a profit that is positive up to the point where marginal revenue equals the marginal cost. Any more production will be causing a marginal profit that is negative due to the fact that marginal cost is greater than marginal revenue. Any extra production will therefore be causing a reduction in the total profits. The firm should hence lower production up to the point where the marginal revenue equals the marginal cost.
(Sullivan and Steven, 2008 p.89-111).