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# Marginal revenue and marginal cost

AP.MICRO:
PRD‑1 (EU)
,
PRD‑1.A (LO)
,
PRD‑1.A.5 (EK)
,
PRD‑1.A.6 (EK)

## Video transcript

let's continue with our orange juice producing example and in this situation I want to think about what a what a rational quantity of orange juice might be well what would be a rational quantity of orange juice to produce given a market price so let's say that the market price right now the market price of orange juice is \$0.50 a gallon and I'm going to assume that there are many producers here so we're going to have to be price takers obviously we want to charge as much as we can per gallon but if we charge any if we charge even a penny over 50 cents a gallon then people are going to buy all of their orange juice from other people so we this is the price that we can charge 50 cents per gallon so if we think about it in terms of marginal revenue revenue per incremental gallon well that first incremental gallon we're going to get 50 Cent's that next incremental gallon we're going to get 50 cents for that one and the next one we get 50 cents as well for the first thousand gallons we're gonna get 50 cents for each of those gallons for the first 10,000 gallons we'll get 50 cents per gallon so our marginal revenue curve looks something like this our marginal revenue is a flat curve right at 50 cents a gallon so that is our marginal revenue at at 50 cents at a market price of 50 cents per gallon now in this situation what's a reasonable quantity that we would want to produce and there's two dynamics here we want to produce as much as possible as much as possible so that we can so that we can spread our fixed costs over those gallons spread our fixed cost is one way of thinking about fixed costs or another way of thinking about it is we have a certain amount of fixed cost we are spending \$1,000 no matter what so why don't we try to get as much revenue as possible to try to make up for those fixed costs or if we think about it in terms of average fixed costs the more quantity that we produce the at the component of the cost for that from the fixed cost go down and down and down so we want to have as much as possible to spread our fixed costs now the one thing that we do need to think about is especially once we kind of get beyond the hump beyond this little dip in the marginal curve and as we're producing more and more units the marginal cost is going up higher and higher and higher we don't want to produce so much that the cost of producing that incremental unit the marginal cost of that incremental unit is more than the marginal cost of that actual or the marginal cost of that incremental unit is not higher than the marginal revenue that we're getting on that incremental unit so until until until marginal revenue is equal to marginal cost or another way of thinking about it you don't want you don't want marginal cost and this is after we go through this little dip here we're trying to do as much as possible marginal cost is going higher and higher higher we don't want to produce this much right over here because here are that cost for that extra gallon is higher than what we're going to get for that extra gallon looks like that cost for that extra gallon might be 53 cents while we're only going to get 50 cents for that extra gallon so every extra gallon we produce over here we're going to be losing money so you don't want you don't want marginal costs to be greater than marginal revenue marginal revenue so when you look at the curves like this it makes sense to just say well when does marginal revenue equal marginal cost and that's this point right over here and that is the rational amount to produce so that is nine thousand units so we're going to be at this line right over here we're going to produce nine thousand gallons of juice our revenue that we're going to get is going to be the area it's going to be the rectangle of the area that's as high as R that's as high as the price we're getting per unit times the number of units so this is going to be the total revenue we get if we were to shade this in and I'm not going to shade it in because it's going to make my whole diagram messy and what is our total cost well we have our average total cost right here this is our average total cost of 48 cents that's this little green triangle right over here so it's 48 cents per unit times the total number of units our costs are the area under the area in this rectangle so if I were to shade this in this little slightly smaller rectangle and so our profits are the difference but the to our total revenue is the area under the rectangle that has this the marginal revenue line is its upper bound and our cost is a rectangle that has our average total cost this line right over here as its upper bound so our profits our profits in this circumstance are going to be the area right over here the height is the difference between our marginal cost which is the same as our marginal revenue and our total cost so it's going to be the height is going to be these two cents right over here we're taking the differing 50 and 48 so it's going to be two cents and then the quantity produced is going to be nine thousand units so nine thousand we're making two cents per unit our to remember our average cost our average total cost is forty eight cents per unit we're selling them at 50 cents per unit so we're making two cents per unit under book 20 we're making two cents per unit two cents times nine thousand units times nine thousand units gives us was that that's 18,000 cents or a hundred and eighty dollars of profit now what I want you to think about and we'll answer this in the next video is does it make sense does it make sense to sell units at all and if so how many should we sell if and here's the question if the market price if the market price is lower than your average total costs so does it make sense and how many units doesn't make us does it make sense to produce let's say if the market price let's say if the market price were forty five cents forty five cents per unit does it make sense for us to produce
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