Average costs (ATC, MC) and marginal revenue (MR)
Marginal Revenue Below Average Total Cost Why it is rational to produce at a loss
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- In the last video we finished up asking ourselves
- how much do we produce
- if the market price is at 45 cents
- and just going with the logic
- that we introduced in the last video
- you want to produce as much as possible
- to spread out the fixed costs
- but you don't want to produce so much
- that the marginal cost is higher
- than your marginal revenue
- and your marginal revenue is your market price
- every unit, every incremental unit
- you're going to get 45 cents
- So you wanna look at the quantity
- where your marginal revenue, the 45 cents
- is equal to your marginal cost
- and you can look at it over here
- so, if you look at our marginal revenue
- so, let's say 45 cents is right over there
- you wanna look
- where the 45 cents is equal to your marginal costs
- It looks like it is right over there.
- You can even see it in our table
- When does our marginal cost equal 45 cents?
- It equals that
- when we produce 8,000 gallons of our juice
- Now, the reason why this is somewhat interesting
- is that at that point
- the amount of revenue that we're getting per unit
- our marginal revenue
- is less than our total cost per unit
- We're selling each unit at 45 cents
- but our total cost for each of those units
- is 48 cents, on average
- So this right over here is our total cost
- So you might say
- look! I'm making a loss on every unit!
- The total amount of revenue I'm getting
- is a smaller rectangle over here
- It's the quantity times the marginal revenue per unit
- so, this is the amount of revenue that I'm getting
- let me colour it in carefully
- That is the amount of revenue that I'm getting
- while my costs are this larger rectangle
- My quantity times my average total cost per unit.
- and so, what I end up with
- is if you take that revenue
- and you subtract that quantity
- you end up with a loss of exactly this much
- you're operating in this situation at a loss
- when you are producing 8,000 units
- and you're getting 45 cents per unit
- So, does it make sense for you to do this?
- And we can even figure out the loss
- You're producing 8,000 units
- and you're selling them for 45 cents a unit
- and it costs you 48 cents per unit to produce them
- on average
- when you put all the costs in
- 48 cents per unit
- So you're losing 3 cents per unit
- per, I guess, gallon
- we're talking about orange juice here
- times 8,000 gallons
- means that we are losing 240 dollars
- 8,000 times 3 cents is 24,000 cents
- which is the same thing as 240 dollars
- so, does it make sense for us to do this?
- Well, one way to think about it
- let's say we didn't do it
- Let's say we're just like
- hey, I'm not going to produce any gallons
- well, then what's going to be our loss?
- Well, we're assuming that this is our fixed cost
- we've already committed ourselves
- to this expenditure right over here
- Whether we produce no drops of orange juice
- we are still going to be spending 1,000 dollars
- So we if produce nothing
- we are garuanteeing ourselves
- a weekly loss of 1,000 dollars
- And this is at least better than that
- So by starting to produce some units
- we are at least able to offset some of that loss
- and we're spreading out that fixed cost
- over more and more and more gallons
- And you might say
- hey! Why don't I just produce more and more units?
- Why don't I go here, maybe I'll produce 9,000 units
- where the marginal cost, all of a sudden
- is higher than our marginal revenue
- and the reason why that won't make any sense to do
- is because if you produce that many units
- then all of a sudden
- each of the incremental units
- that you're producing beyond the 8,000
- you're losing money on those
- That 8,000 and first unit
- the marginal cost is going to be higher
- than the marginal revenue
- that you're bringing in on that unit
- so you're going to be losing money
- You're going to start having a lower profit
- than even the negative 240 dollar loss
- so we'll start going into negative 240 something
- negative 250 and so forth and so on
- so you still don't wanna produce beyond that point
- and we'll touch more deeply on that in future videos
- but this is essentially what differentiates
- the short term supply curve
- from the long run supply curve
- In the short term
- we're going to assume that we have these fixed costs
- and so, it's just going to make sense
- to produce equivelent to our marginal costs
- But over the long run
- maybe our fixed items
- our capital
- our machinery wears off
- or maybe the contract for my emplyees wears off
- and then we have a different cost structure
- over the long term
- and we'll think about that in another video
- But the simple answer is
- assuming these really are your fixed costs
- you still want to produce as many units as possible
- so that your marginal cost
- is equal to your marginal revenue
- which in this case, is the market price
- We are price takers
- so it actually is a rational thing
- to produce 8,000 units and take a loss on that
- and take 240 dollar per week loss
- as opposed to producing nothing
- and taking a thousand dollar per week loss
- now, it might not be rational
- once these things have been worn out
- like your robots and your employee's contracts
- it might not be rational
- to continue them past their term
- and we'll think about that more in another video
- because, obviously, we are running at a loss
- and this is not necessarily a good business to be in
- but now that we've gotten int the business
- we might as well stay in it
- in order to recoup some of our costs here
- or at least spread them out
- or at least not have a thousand dollar per week loss
- Anyways. See you in the next video
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At 5:31, how is the moon large enough to block the sun? Isn't the sun way larger?
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