![]() ![]() Conversely, to the right of the profit-maximizing point, marginal revenue is less than marginal cost. Increasing its output is thus a good idea. The increase in output yields extra profit, which is equal to A. We see that an increase in output yields extra revenue equal to the areas A + B and extra costs equal to B. If it increases its output, the extra revenue it obtains will exceed the extra cost. Suppose a firm is producing below this level. To the left of the point marked “profit-maximizing quantity,” marginal revenue exceeds marginal cost. The opposite is true to the right of that point.įigure 6.18 "Optimal Pricing" shows this idea graphically. To the left of the point marked “profit-maximizing quantity,” marginal revenue exceeds marginal cost so increasing output is a good idea. From the law of demand, she should think about decreasing the price. This tells the marketing manager that it is a good idea to increase output. As a result, it leads to an increase in profits: specifically, profits will increase by $2. ![]() An increase in output leads to a bigger increase in revenues than in costs. From these two pieces of information, the marketing manager knows that an increase in output would be a good idea. This means it would cost an additional $3 to produce one more unit. The marketing manager has also spoken to her counterpart in operations, who has told her that the marginal cost is $3. This means that if the firm increases output by one unit, its revenues will increase by $5. Suppose that a marketing manager has estimated the elasticity of demand, looked at the current price, and used the marginal revenue formula to discover that the marginal revenue is $5. It doesn’t matter if we think about choosing the price and accepting the implied quantity or choosing the quantity and accepting the implied price This is just a matter of convenience: a firm chooses a point on the demand curve, and it doesn’t matter if we think about it choosing the price and accepting the implied quantity or choosing the quantity and accepting the implied price ( Figure 6.17 "Setting the Price or Setting the Quantity").įigure 6.17 Setting the Price or Setting the Quantity Yet the pricing decision is easier to analyze if we think about it the other way round: a firm choosing what quantity to produce and then accepting the price implied by the demand curve. In the real world of business, firms almost always choose the price they set rather than the quantity they produce. When marginal revenue equals marginal cost, the change in profit is zero, so a firm is at the top of the profit hill. The change in a firm’s profit is equal to the change in revenue minus the change in cost-that is, the change in profit is marginal revenue minus marginal cost. When a firm changes its price, this leads to changes in revenues and costs. zip file containing this book to use offline, simply click here.įigure 6.16 Changes in Revenues and Costs Lead to Changes in Profits You can browse or download additional books there. More information is available on this project's attribution page.įor more information on the source of this book, or why it is available for free, please see the project's home page. Additionally, per the publisher's request, their name has been removed in some passages. However, the publisher has asked for the customary Creative Commons attribution to the original publisher, authors, title, and book URI to be removed. Normally, the author and publisher would be credited here. ![]() This content was accessible as of December 29, 2012, and it was downloaded then by Andy Schmitz in an effort to preserve the availability of this book. See the license for more details, but that basically means you can share this book as long as you credit the author (but see below), don't make money from it, and do make it available to everyone else under the same terms. This book is licensed under a Creative Commons by-nc-sa 3.0 license. ![]()
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