Finding Where Marginal Revenue Is Equal To Marginal Cost

By getting the marginal revenue to be equal to the marginal cost there are two things that are achieved by it:

Minimizes the loss of the company if it has to accept a loss due to the low price of the product.

Maximizes the benefits of the company if the price of the product is enough for benefits to be produced.

The idea behind marginal revenue = marginal cost is very simple and is basically an analysis of cost benefit. if producing and selling a bottle of orange juice generates more revenue then what it costs to produce it, then you should make it. If not, then don’t. It’s that simple actually.

Lets look at our example. Lets imagine that a factory of orange juice can sell each bottle of orange juice they produce at $2 per bottle. Economy experts like to say that the marginal revenue of each bottle is $2 because each bottle that is sold gives an additional $2.

The administrators of the company need to decide the production level based on if the additional bottle costs more or less then the $2 of marginal revenue that the company would receive by selling it.

It is important to be careful here. It is essential to remember that the pertinent cost that the business people look at is the marginal cost of an individual bottle of orange juice, marginal cost. If they are considering producing that bottle in particular, they need to isolate the production cost of that bottle from the costs of all the bottles that were previously produced, to compare it with the revenue that the bottle would generate if they produced and sold it. The marginal cost does exactly that, by ignoring all the previous bottles and concentrating on how much it costs to make the new bottle of orange juice.

If the marginal cost of a bottle of orange juice is $2, then obviously there will be a gain by producing it and the administrators will choose to make it. On the other hand if the marginal cost is over $2, producing that bottle of orange juice would cause a loss and the administrators would choose not to make it.

By looking at the marginal cost of each bottle and comparing it with the marginal revenue they could obtain by selling it, the administrators can determine exactly how many bottles to produce. It is possible to do the necessary comparisons by looking at a cost chart but it is even easier to do the comparisons graphically.

As was mentioned before, producing where Marginal Revenue equals Marginal Cost does not guarantee any benefits, but it can at least ensure that you only produce the bottles that generate more money then it costs to produce them. The reason this formula cannot guarantee benefits is because it does not take into account the fixed costs you have to pay, no matter what level your product is. Even if you only produce the bottles for which the marginal revenue be at least as much as the marginal cost, it is possible you may not obtain enough earnings to pay for the fixed costs.