Marginal Analysis

In order for any business to be successful they would need to know how to make the most profit for the goods they are producing and selling. In this paper I am going to explain some of the key terms that companies need to keep in mind when operating their business. First, we will start with marginal revenue, which is defined simply as the extra revenue that is made for each additional unit of a product that is sold. This is directly related to marginal cost, which is what it costs the company to make that additional unit of product. Next there is total cost and total revenue. Total cost is what the company spends to produce a certain quantity of its product. This includes the cost of all the materials, labor, production, etc. Total revenue is defined as the total amount of money received from producing and selling that given quantity of a product. Total revenue is not to be confused with profit however. Profit comes from subtracting the total cost of units produced from the total revenue made. Simply put: Profit = Total revenue – total cost. In order to determine profit maximization using total revenue to total cost Company A would need to find the optimal output level. For each widget Company A produces both the total cost and total revenue increase. However, if total cost ever exceeds the total revenue the company will begin to lose money. The chart below shows the point at which Company A would reach their profit maximization using total cost to total revenue. 8 widgets is the optimal output for profit maximization. If one more widget is produced the profit begins to decrease (shown below).

Quantity

TR

TC

TR – TC

0

$0.00

$10.00

-10

1

$150.00

$30.00

120

2

$290.00

$50.00

240

3

$420.00

$80.00

340

4

$540.00

$120.00

420

5

$650.00

$170.00

480

6

$750.00

$230.00

520

7

$840.00

$300.00

540

8

$920.00

$380.00

540

9

$990.00

$470.00

520

10

$1,050.00

$570.00

480

11

$1,100.00

$680.00

420

12

$1,140.00

$800.00

340

13

$1,170.00

$930.00

240

14

$1,190.00

$1,070.00

120

15

$1,200.00

$1,220.00

-20

Now in order for Company A to get profit maximization to make the most of their time, money, and materials they would need to determine the amount of widgets that would need to be produced in order for it to be equal to their marginal revenue. Profit Maximization is when (Marginal Revenue = Marginal Cost). Using the information given about Company A we will determine how to get the marginal cost as well as the marginal revenue. Marginal cost is the change in total cost depending on the increase or decrease in quantity produced. It’s calculated by taking the total cost of one widget of the product and subtracting it from the total cost of the next widget made. So for instance, the total cost of 5 widgets being produced is $170 and the total cost of 6 widgets produced is $230. So to get the marginal cost you would subtract $170 from $230, which is $60. Looking at the graph using this calculation you can see that the marginal cost increases by $10 for every extra unit of product produced. Marginal revenue is found by getting the difference of the total revenue from each additional unit produced. So for example, for 8 units of widgets the total revenue is $920. Subtract $840(7 units) from $920 to get the marginal revenue: $80. Using the given scenario and the chart below you can see that the marginal revenue decreases by $10 for…