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## AP®︎/College Microeconomics

### Course: AP®︎/College Microeconomics > Unit 3

Lesson 2: Short-run production costs- Fixed, variable, and marginal cost
- Marginal cost, average variable cost, and average total cost
- Graphs of MC, AVC and ATC
- Marginal revenue and marginal cost
- Short-run production costs: foundational concepts
- Marginal revenue below average total cost
- How costs change when fixed and variable costs change
- Graphical impact of cost changes on marginal and average costs
- Short-run production costs

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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)

Learn about rational production quantity using an orange juice example. The market price is 50 cents per gallon, and we want to maximize profit. We find the point where marginal revenue equals marginal cost, which is 9,000 gallons. At this quantity, we make 2 cents profit per gallon, totaling $180 profit. Created by Sal Khan.

## Want to join the conversation?

- Why not just produce at 8000 units instead of 9000 units? Wouldn't you make the same profit ($140; total revenue - total cost)? It seems that producing 9000 is a waste of time because you're not making any extra profit on that 1000 additional units.(16 votes)
- The example is an approximation, if the increments of quantity were smaller the actual profit maximizing quantity would be found as between 8000 and 9000 (probably)(7 votes)

- what is true when the marginal revenue and marginal cost are equal?(6 votes)
- When marginal revenue equals marginal cost, it means that the additional revenue generated from selling 1 more unit (of whatever it is you're selling) exactly offsets the additional cost of producing that 1 unit.

In a perfectly competitive market, firms will increase the quantity produced until their marginal revenue equals marginal cost. This is because when marginal revenue is*greater*than marginal cost, the difference represents**profit**to be earned (and firms are assumed to be "profit-maximizing" and, when dealing with perfect competition, "price-takers").

Also, remember, if Marginal cost is GREATER than Marginal Revenue, then a firm won't produce any more goods (because that would be like burning money...).

Does this make sense?

Hope this helps!(23 votes)

- If Marginal Revenue = Price and Price multiplied by Quantity = Total Revenue, then why does the Total Revenue - Total Cost not equal the Profit calculated?

0.02 x 9000 = 180 (Quantity x (MC-ATC)

0.50 x 9000 = 4500 (Quantity x Price)

4500 - 4360 = 140 (TR - TC)

I can't work out why these don't match?(8 votes)- Rounding error? I see TC=4360 at 9000 output in the table above which gives you the $140 profit, but if you take the ATC of $0.48 and convert that to TC then that's 0.48*9000 = $4320. And $4500-$4320 is $180. Not sure what is wrong in the numbers to cause this.(10 votes)

- Wont it make a great profit if the MR>MC compared to when MR=MC? Since MR and MC offset each other.(4 votes)
- No. Marginal revenue is the amount of revenue one could gain from selling one additional unit. Marginal cost is the cost of selling one more unit. If marginal revenue were greater than marginal cost, then that would mean selling one more unit would bring in more revenue than it would cost. If that is the case, then why would you not sell that additional unit?(11 votes)

- What happens when marginal cost intersects the marginal revenue curve twice? Which quantity is the profit maximizing quantity?(3 votes)
- The one that produces the highest profit would be best.(5 votes)

- Will in some cases I would prefer to produce the number of units where my average total cost is minimum? Because in that case while my revenue will be less; but my profit margin would be greater? (Clearly this argument is not applicable to this case as margin is too small)(3 votes)
- Profit margin is always greatest when MC=MR even if ATC is lowest elsewhere, this is what leads to inefficiency in market structures that aren't in perfect competition such as an oligopoly. This is because MC is the cost for the next unit and MR is the revenue gained for that same unit. If MC>MR then it will always shrink your profits since you incur more in cost for that unit then you gain in revenue. If MR>MC then you will always increase profits as the revenue gained from that next unit exceeds the cost for that unit. If MR=MC=ATC=P then it is efficient.

Just to show how the lowest ATC can hurt profits, if ATC=50 and MC=49 and MR=1, then despite the fact that the ATC will decrease (MC<ATC) the profit margin will decrease since TC (total cost) increases by 49 while TR (total revenue) increases by just 1.(3 votes)

- Why the company's management would not want to produce and sell either more or less than the equal amounts of marginal cost and marginal revenue?(3 votes)
- When marginal cost equals marginal revenue, then profit is maximized. When marginal revenue is greater than marginal cost, that means creating one more product would bring more in revenue than it would cost, so profit would increase. When marginal revenue is les than marginal cost, creating that last unit cost more than it brought in as revenue, so profit had decreased.(2 votes)

- Why is there a dip in the marginal cost curve? I don't really get it. Help anyone?(1 vote)
- Sal explained this in the previous video: 'Marginal cost and average total cost' at1:10. The marginal costs go down for the first 3000 gallons of juice. After that we're encountering a small problem.

The local, cheap suppliers ran out of oranges, so we have to move to other suppliers if we want to make and thus sell more juice. The new suppliers are probably slightly further away, so we have to make more costs for transportation. It's also possible those suppliers charge a higher price for their oranges.

There are more reasons to think of, but I hope those give you an idea of why the marginal costs increase.(4 votes)

- At2:18, why exactly does marginal cost rise?(2 votes)
- The answer to this question takes us to concept of efficiency and inefficient production. I would add certain more assumptions to above example mentioned by Sal. Suppose the Juicer you have capacity of juicing 10,000 oranges a day efficiently, and after juicing 10,000 oranges, it gets heat up, consumes more energy and produces juice at higher cost. So the variable cost of juicing oranges beyond 10,000 is more than till 10k. Juicer is becoming less efficient and that's why marginal cost is rising. As we might see in later videos, you might consider buying another juicer and add to your fixed cost to reduce this variable cost.(2 votes)

- When the MR=MC ,they offset each other, then what is the point of producing? Looking forward for your answers.(1 vote)
- Marginal cost and revenue are not the same thing as all up cost and revenue. Marginal cost or revenue is referring to the additional profit or cost per unit produced. When they are equal your profits are maximized because you are producing the exact amount of goods you need to, no more and no less. If marginal revenue is less than marginal cost then you are producing too much (supply is too high so prices decline) and when marginal revenue is more than marginal cost then you are not producing enough (prices are climbing too high so consumers are not buying the product).(3 votes)

## Video transcript

Let's continue with our orange juice producing example In this situation I want to think about what a rational quantity of orange juice might be 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 is 50 cents a gallon and I'm going to assume that there are many producers here so we're going to have to be price takers and obviously we want to charge as much as we can per gallon but 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 this is the price that we can charge 50 cents per gallon So, if we think about it in terms of marginal revenue per incremental gallon well that first incremental gallon we're going to get 50 cents the next incremental gallon we're going to get 50 cents for that one and the next one we're going to get 50 cents as well. for the first thousand gallons we're going to get 50 cents for each of those gallons for the first 10 thousand gallons we'll get 50 cents per gallon So, our marginal revenue curve will look something like this Our marginal revenue is a flat curve right at 50 cents a gallon so that is our marginal revenue 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? Now there's two dynamics here we want to produce as much as possible so that we can spread our fixed cost over those gallons that's one way of thinking about it or, another way of thinking about it is we have a certain amount of fixed cost we are spending $1000 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 cost the more quantity that we produce the component of the cost for that from the fixed cost goes 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 little dip in the marginal cost curve and as we produce 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 marginal revenue is equal to marginal cost or another way to think about it you don't want marginal cost and this is after we go to this little dip here we're trying to do as much as possible marginal cost is going higher and higher and higher we don't want to produce this much right over here because here the 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 gonna 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 marginal cost to be greater than marginal revenue so when you look at the curves like this and make sense to just say 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 9000 units so we're going to be at this line over here we're gonna produce 9000 gallons of juice our revenue that we're going to get is going to be the rectangle of the area that is high as the price we're getting per unit times the number of units so this is gonna be the total revenue we get if we were to shade this in I'm not gonna shade this in because it's going to make my whole diagram messy and what's our total cost? well, we have our average total cost right here this is our average total cost at 48 cents that's the little green triangle here so it's 48 cents per unit times the total number of units our cost, 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 between the two our total revenue is the area under the rectangle that has this marginal revenue line as its upper bound and our cost is the rectangle that has our average total cost this line right over here as its upper bound so 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 the heigh is going to be this two cents right over here we're taking the difference of 50 and 48 so it's gonna be 2 cents and then, the quantity produced is going to be 9000 units so 9000 we're making 2 cents per unit remember, our average cost our average total cost is 48 cents per unit we're selling that 50 cents per unit so we're making 2 cents per unit that's not 20 we're making 2 cents per unit 2 cents times 9000 units gives us that's 18000 cents, or 180 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 to sell units at all and if so, how many units should we sell if, and here is the question if the market price is lower than your average total cost so does it make sense and how many units does it make sense to produce let's say if the market price were 45 cents per unit does it make sense for us to produce