Video Transcript: Marginal Revenue and Marginal Cost

Hello, welcome back. In this video, we're going to discuss marginal cost and  marginal revenue. Marginal revenue, marginal cost. The marginal cost of  production and marginal revenue are economic measures used to determine the amount of output and the price per unit of a product to maximize profits. A  rational company always seeks to maximize its profits, and the relationship  between marginal revenue and the marginal cost of production helps to find the  point at which this occurs. The point at which marginal revenue equals marginal  cost maximizes a company's profit. The marginal cost of production measures  the change in total cost of a good that arises from producing one additional unit  of that good. The marginal cost is calculated by dividing the change in the total  cost by the change in quantity, for example, the total cost of producing 100 units  is of a good is $200 The total cost of producing 101 units is $204 The average  cost of producing 100 units is $2 or $200 divided by 100 units. However, the  marginal cost for producing the 100 and first unit is $4 or 204 minus 200 divided  by 101 minus 100 So the marginal revenue measures the change in the revenue that arises when one additional unit of a product is sold. The marginal revenue is calculated by dividing the change in the total revenue by the change in the  quantity. For example, again, suppose the price of a product is $10 and the  company produces 20 units per day. The total revenue is calculated by  multiplying the price by the quantity produced, in this case the total revenue is  $200 or $10 times 20. The total revenue from producing 201 units is $205 The  marginal revenue is calculated as $5 or 205 minus 200 divided by 21 minus 20,  so if you look, it's basically five divided by one. If you break it down, so 205  minus 200 is 5, 21, minus 20 is one, five over one. So, so you can see that five  divided by one is five, right? So the marginal revenue is $5 when marginal  revenue and the marginal cost of production is equal, profit is maximized at that  level of output and price. For example, a toy company can sell 15 toys at $10  each. However, if the company sells 16 units, the selling price falls to $9.50  each. The marginal revenue is $2 or 16 times $9.50 minus 15 times 10, divided  by 16 minus five. So, the simple math you can do very quickly, and you can find  that the marginal cost is $2 The company maximizes its profit at this point  because the marginal revenue is equal to its marginal cost. When marginal  revenue is less than the marginal cost of production, a company is producing  too much and should decrease its quantity supplied until margin marginal  revenue equals the marginal cost of production. So, when marginal revenue is  less than marginal cost. A company is producing too much, and therefore should decrease the quantity supplied, right? Because you want to bring marginal cost  and marginal revenue into equilibrium to make sure that you're maximizing  profit, because if you're producing too much and it's costing you too much, then  you're burning through your marginal profit, so let's look at the example on the  graph over here. I'm going to go over here, so you can see the schedule in  production to the left. This column represents the gallons of juice that can be 

produced, it's fixed costs, it's variable costs, then it's total cost, right. So then  we'll have the average fixed cost of production, so forth, average variable cost,  average total cost, marginal cost, right. So at 1000 gallons of juice, you can see  that the average variable cost is 50 cents, and the average marginal cost is 50  cents. So, you can see that the market price is 50 cents per gallon, right? So, 50 and 50, right here at 1000 as our base here, right at this level, right, so. 50 cents per gallon. Now we want to look for an opportunity that will allow us to minimize  our costs, right. So we want to look at this figure, so 9000 gallons, we can find,  you can see that our average total costs are less than the marginal costs, right?  So our average total costs are less, so if we.. this is the first time that you'll find  this on this schedule, the average costs are always greater than the marginal  cost until we get to the 9000 gallons of juice produced, right? So this is where  we can, we've brought our marginal costs up high enough, right, because if  we're maximizing our profit, remember that marginal cost will equal marginal  revenue, so we have to assume if we are in equilibrium in our production, that  our revenue will equal 50 cents, right. So we'll have just as much equal, we'll  have just as much marginal revenue as we do marginal cost, but where the  advantage comes in is because we've produced the extra 1000 gallons of juice,  it has pushed our average total cost down 48 cents, right. So our marginal, our  average total cost is two cents less than the marginal total cost. So if you look at the graph, you can see our two intersecting points are here, right. So this is  where our marginal cost at 1000 gallons 50 and 50, right? You can see this is  where they intersect to get the market price per gallon of 50 cents, represented  by this line. Now our marginal revenue and our marginal cost, right? So we can  come down here and we can look again where we intersect, right? So our blue  line represents total cost. So where does total cost intersect marginal revenue  right here? Right, so this is at 50 cents now we can graph out our average total  cost at 48 cents. So we drew out the line here. This yellow line represents at  9000 gallons the 48 cent average cost, right? So now our average costs are  here now, because our marginal revenue is two cents greater than our average  total cost. This represents our profit margin, right? Our additional profit, or our  marginal profit. So, because we created, or we produced an extra nine or an  extra 1000, or we created 9000 gallons right of juice. We were able to create an  additional profit by pushing down our average cost, raising our marginal cost,  which, if we're in equilibrium, our marginal cost will equal our marginal revenue,  so we're bringing in by producing the 9000 we're bringing in an additional two  cents greater than the average total cost in revenue, creating the additional  profit margin, because our marginal cost and marginal revenue are equal, and  we push down our average total cost by creating the 9000 units. We are able to  create marginal profit by producing more and minimizing costs and raising our  marginal revenue, marginal cost to be equal, therefore creating the extra two  cents of profit margin.