- This topic has 7 replies, 5 voices, and was last updated 11 years ago by
.
- Posts
Hi John,
Despite your wonderful lectures, I still don’t understand the statement “Maximum Profit occurs when Marginal Revenue = Marginal Cost”. Please can you explain it further?
I understand the concept of by reducing the selling price, you are likely to sell more units and visa versa. And I also understand that the marginal revenue is the revenue gained by selling one extra unit, and the marginal revenue (marginal cost) is the cost of producing one extra unit but I still don’t understand the statement “Maximum Profit occurs when Marginal Revenue = Marginal Cost”. Please can you explain it further?
I guess it is down to numbers of units being sold and the selling price per unit.
I thought maximum profit would occur when the difference between revenue and costs is greatest?Many thanks,
Stuart
Marginal profit = Marginal revenue – marginal cost. Where the marginal profit is positive, this indicates that more goods should be produced to take advantage of this marginal change (increase) in profit. If too much goods are produced, then the marginal profit becomes negative as the benefit of producing more goods leads to diminishing returns. In this regard, less goods should be produced to reduce the marginal loss to zero. When marginal revenue=Marginal cost, then there is no further benefit that can be derived from either producing more goods or reducing the amount of goods sold. At this point, you are getting the most profit you can based on the revenue that can be earned and the costs to be expended in making the goods.
If you have an understanding of calculus, then marginal profit would be the differentiation of a revenue/quanity and cost/quantity equation, but no need to worry about this if you don.t understand calculus
Stuart:
Maximum profit is indeed where the difference between revenue and cost is the greatest!
The idea of it being where marginal revenue equals marginal cost is this:
If we drop the selling price to sell one extra unit, then the total revenue will change and the extra revenue is the marginal revenue. However the extra revenue from dropping the price more to sell another extra unit will be different (and will be lower – watch the lecture or look at our course notes. The tabular approach should make this clear).
Equally, if we sell one more unit then we need to produce one more unit and so the total costs will increase – the extra cost is the marginal cost.
Whatever profit is being made at present, if we drop the price to sell an extra units, then the profit will increase provided the extra revenue from the one unit is greater than the extra cost of the one unit.
Provided this is the case then it is worth dropping the price to sell one more unit.However, there will come a time when the extra revenue is less than the extra cost. In this case, it would mean that the total profit would fall from selling one more unit. It would not be worth dropping the price to sell one more unit.
Maximum occurs when the extra revenue equals the extra cost – then the total profit will not change and is a maximum.
It is hard to explain just in words. Have you watched the lecture on this (with our course notes)? In the lecture I explain the above with numbers. The tabular example should make it clear what is happening, but it is the example with equations where although the principle is the same, the marginal revenue/marginal cost idea becomes important.
Hai Yen:
For Paper F5, micro economics is not really terribly relevant. Have you watched my lecture on this? It does go through the reasoning behind what we do.
I have a problem with the following question from the study text:
AB has used market research to determine that if a selling price of $250.00 is charged for product G, demand will be 12000 units. It has been established that demand will rise or fall by 5 units for every £1.00 fall/rise in the selling price. The marginal cost of product G is $80.00.
Required:
If marginal revenue = a – 2bQ when the selling price (P) = a – bQ, calculate the profit-maximising selling price for product G.
Answer:
b = 1/5 = 0.2
a = $250 + ((12000/5)*$1) = $2650
MR = 2650 – ((2*.02)Q – 2650 – 0.4QProfits are maximised when MC=MR, ie when 80 = 2650 – 0.4Q
2650 – 80 = 2570 * 10/4 = 6425
Profit maximisation demand = 6425
Now, substitute the values into the demand curve equation to find the maximisation selling price
P = a – bQ
P = 2650 – (0.2*6425)Therefore profit maximising price = $(1540-1285) = $1365.
I understand all the figures apart from the 10/4, where did this come from?
Thanks
I do not know why they wrote it like that, but multiplying by 10/4 is the same as dividing by 0.4
MC = MR when 80 = 2650 – 0.4Q
So, 0.4Q = 2570
So, Q = 2570 / 0.4 = 6425
- You must be logged in to reply to this topic.