Problem 15
Question
When production is \(2000,\) marginal revenue is \(\$ 4\) per unit and marginal cost is \(\$ 3.25\) per unit. Do you expect maximum profit to occur at a production level above or below 2000? Explain.
Step-by-Step Solution
Verified Answer
Maximum profit occurs above 2000 units, since MR > MC.
1Step 1: Understanding the Problem
We are given the marginal revenue (MR) and marginal cost (MC) when production is 2000 units. MR = $4 per unit and MC = $3.25 per unit. Marginal revenue is the additional revenue from selling one more unit, while marginal cost is the additional cost of producing one more unit.
2Step 2: Applying the Profit Maximization Rule
The rule for maximizing profit is to continue increasing production as long as marginal revenue (MR) exceeds marginal cost (MC). This is because producing an additional unit adds more to revenue than to cost, thereby increasing profit.
3Step 3: Comparison of MR and MC
At the given production level of 2000 units, compare MR and MC: MR = $4 and MC = $3.25. Since MR > MC, producing one more unit will increase profit because the revenue from selling the additional unit exceeds the cost of producing it.
4Step 4: Conclusion on Profit Maximization
Since marginal revenue exceeds marginal cost at 2000 units (MR > MC), profit can be increased by producing more. Therefore, the production level that maximizes profit is above 2000 units as long as MR continues to be greater than MC.
Key Concepts
Marginal RevenueMarginal CostProfit Maximization
Marginal Revenue
Marginal revenue (MR) is the additional income a company earns from selling one extra unit of a product. It's a crucial concept because it helps businesses understand the impact of increasing their sales volume.
In simple terms, it's the extra cash a business gets for each additional item sold. This measure helps businesses decide whether they should continue increasing their production and sales levels.
When marginal revenue is higher than marginal cost, it typically means that producing more units will lead to more profit. That's because each new unit sold brings in more revenue than it costs to produce.
In simple terms, it's the extra cash a business gets for each additional item sold. This measure helps businesses decide whether they should continue increasing their production and sales levels.
When marginal revenue is higher than marginal cost, it typically means that producing more units will lead to more profit. That's because each new unit sold brings in more revenue than it costs to produce.
- For example, in the problem above, the marginal revenue of $4 per unit communicates that for each additional unit produced and sold, the company earns $4 more.
Marginal Cost
Marginal cost (MC) represents the additional cost of producing one more unit of a product. It's an essential factor for determining the profitability of incremental production.
This measure provides insights into how much producing an extra unit will cost the business. Businesses should closely monitor changes in marginal cost to ensure efficient production processes.
Typically, marginal cost includes expenses like materials, labor, and additional operational costs that come with increased production.
This measure provides insights into how much producing an extra unit will cost the business. Businesses should closely monitor changes in marginal cost to ensure efficient production processes.
Typically, marginal cost includes expenses like materials, labor, and additional operational costs that come with increased production.
- In the given scenario, the marginal cost is $3.25 per unit, implying that each additional unit produced incurs a cost of $3.25.
- If the marginal cost increases significantly, it might outweigh the marginal revenue, indicating that increasing production could reduce profit.
Profit Maximization
Profit maximization involves finding the production level where the difference between total revenue and total cost is greatest. Economically, this is where marginal revenue equals marginal cost (MR = MC).
The rule for maximizing profit in economics is to continue increasing production as long as marginal revenue exceeds marginal cost. This is because each additional unit brings in more revenue than it costs to make, thereby increasing overall profit.
The rule for maximizing profit in economics is to continue increasing production as long as marginal revenue exceeds marginal cost. This is because each additional unit brings in more revenue than it costs to make, thereby increasing overall profit.
- As shown in the exercise, since MR ($4) is greater than MC ($3.25) at the 2000-unit production level, we can increase profit by producing more units above this production level.
- As production increases, these marginal values might change, requiring continuous adjustment to maintain profit maximization.
Other exercises in this chapter
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