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Marginal Cost and Marginal Revenue

Referencing Styles : Harvard | Pages : 2

Why does marginal cost equal marginal revenue?

The profit maximizing condition of a firm is given by the equality of its marginal cost and marginal revenue. The marginal cost of a firm can be defined as the increase in magnitude of the production cost due to unit increase in production of the good that the firm manufactures. The marginal revenue is the incremental change in revenue due to unit increase in sales of product. According to the market theory, marginal revenue needs to equal with marginal cost for maximizing the profit. Marginal revenue is downward sloping and marginal cost is U-shaped curve in the case of monopoly market. The marginal cost curve cuts the marginal revenue curve from the below. Therefore, the upward sloping portion of the marginal cost curve intersects the downward sloping marginal revenue curve. At the point of the intersection, marginal revenue equals the marginal cost. Assuming a company, that produces cars to explain the theory of equality between marginal revenue and marginal cost. Suppose the car company produces one car for $10 each, two for $12 each and three for $15and so on. Therefore, marginal cost for producing second unit is $2 and third unit is $3 (considering only upward sloping portion of the marginal cost curve). On the other hand marginal revenue curve has been assumed to be downward sloping that means every extra unit of car sold add value to the total revenue at declining rate and thus it is constant. Therefore, marginal revenue for selling each car assumed to be $7. Thus, when the marginal cost is below marginal revenue then the firm should keep on producing more as accruing less amount of cost attracts more revenue. Producing more at this point will increase the profitability of the company. However, if the marginal cost exceeds marginal revenue, suppose adding one more unit of car to the production increases the cost by $9, then by selling extra unit of car the company will make less revenue and thereby less profit. Thus, at the point the company should not produce more rather it should decrease it production such that the marginal cost decrease to $7, which is equal to the marginal revenue. Thus, producing below or above this point the company would make less profit or loss respectively. Therefore, for maximizing profit the company should produce at the point where marginal revenue marginal cost. However, in the case of perfect, marginal cost curve intersects the marginal revenue curve two times. The first intersection occurs when the marginal cost curve is downward sloping and the second intersection occurs when marginal cost curve is upward sloping. However, it is theoretically suggested that the firm should operate in the second intersection point as at this point the revenue of the firm is maximized. However, the marginal cost curve at its U-shaped part gives the minimum cost for adding up one unit of good in the production process. In the oligopoly market, structure the profit maximizing condition satisfies at the point where marginal revenue equals the marginal cost and thus it is no exception and acts like the other market structure that is monopoly and perfect competition. However, the quantity and price offered by the different markets are different at the profit maximizing point that is at MR=MC. In the case of both oligopoly and monopoly, the price at profit maximization quantity is higher than the perfectly competitive market price. However, price in the oligopoly market is lower than the monopoly market  except in the case of collusion in the oligopoly market.

What is true when the marginal revenue and marginal cost are equal? 

The profit is always maximized when marginal revenue is equal to marginal revenue, hence, profit maximization condition holds true at this point of equality between marginal revenue and marginal cost. A firm running production where marginal cost is below the marginal revenue, then the firm has the opportunity to gain more by producing more. Similarly, if the firm produces at the point where marginal cost is above the marginal revenue then the firm incurs loss by producing at this point. Hence, it is not beneficial for the firm to produce at any of the point other than the point of equality of marginal revenue and marginal cost. In any market structure be it perfect competition or monopoly market profit is maximized at the point where marginal revenue equals marginal cost.

What happens when marginal cost intersects the marginal revenue curve twice? 

In case of the monopoly market structure the marginal cost curve intersects the marginal revenue curve once from the below, whereas, in case of perfect competition marginal cost curve intersects the marginal revenue curve twice, at first from up and secondly from the below. In case of perfect competition, the intersection between marginal cost curve and marginal revenue curve has different implications due to the number of times they intersect with each other.  Considering, the case of marginal cost curve cutting the marginal revenue curve from above at first. At this point a firm in perfect competition has the benefit of producing more as the marginal cost is downward sloping at this portion and increase in every unit of production will reduce the cost of production and thus it is beneficial for the firm even if the profit maximization condition is met. Hence, the revenue of the perfectly competitive firm will keep rising until the marginal cost curve intersects the marginal revenue curve for the second time. . The marginal cost is minimum at the base of the U-shape of the marginal cost curve. Beyond this point, it is beneficial for the firm to produce more as the marginal cost is below the marginal revenue curve, any increase in production will increase the revenue of the firm, and thus it is better for the firm to produce until the marginal cost equals the marginal revenue. However, if the marginal cost exceeds the marginal revenue and the frim then keep on producing the firm will incur loss and the any production in this case makes the firm inefficient and unsustainable. Therefore, in perfect competition, the profit maximization condition meets twice by the firm, but it is not feasible and profitable for the firm to produce at the first point of attainment of profit maximization output and thus the firm will produce at the second point of intersection between marginal revenue curve and marginal cost curve.

Which quantity is the profit maximizing quantity? 

According to microeconomic theory of market structure, the profit is maximized at the quantity at which the marginal revenue equals the marginal cost of the firm. However, the equality point of the marginal revenue and marginal cost gives the profit maximizing quantity for perfectly competitive market. Alternatively, in the case of monopoly market structure the quantity given by the equality point between marginal revenue and marginal cost is lower than the perfectly competitive market as marginal revenue curve is downward sloping in monopoly market structure unlike perfectly competitive market. In case of monopoly market, the profit maximizing quantity is priced higher than in the perfectly competitive market. Hence, with change in market structure the profit maximizing quantity also changes. It is required to mention that two different profit maximization point occurs in the case of perfect competition but both the points give different quantity. Hence, in perfectly competitive market there are two profit maximizing quantity. In other market structures, such as oligopoly, monopolistic competition and monopoly there is only one profit maximizing quantity.

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