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## Production and costs in the short run

Current time:0:00Total duration:5:55

# Marginal revenue below average total cost

AP Micro: PRD‑1.A.4 (EK), PRD‑1.A.5 (EK), PRD‑1.A.6 (EK), PRD‑1.A.7 (EK)

## Video transcript

In the last video,
we finished up asking ourselves, how
much do we produce if the market price is at $0.45? 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 cost. 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 $0.45. So you want to look
at the quantity where your marginal
revenue, the $0.45, is equal to your marginal cost. So we could look
at it over here. So if we look at our
marginal revenue, let's say $0.45 is
right over there. You want to look where the $0.45
is equal to your marginal cost. And it looks like it
is right over there. Now we could even
see it on our table. When does our marginal
cost equal $0.45? It equals that when we produce
8,000 gallons of our juice. Now the reason why this
is somewhat interesting is 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 $0.45, but our total cost for
each of those units is $0.48 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 color 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 out that quantity, you end up with a loss
of exactly this much. You are operating, in
this situation, at a loss. You're operating at a loss when
you are producing 8,000 units and you're getting
$0.45 per unit. So does it make sense
for you to do this? And we can even
figure out the loss. You are producing 8,000 units. You're selling them
for $0.45 a unit. And it costs you $0.48 per unit
to produce them on average when you put all the costs
in, $0.48 cents per unit. So you are losing $0.03
per unit, I guess gallon. We're talking about
orange juice here. And it's times
8,000 gallons, means that we are losing
we are losing $240. 8,000 times $0.06
is 24,000 cents, which is the same thing as $240. 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
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/ So if we produce nothing, we are
guaranteeing ourselves a weekly loss of $1,000. And so 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 costs over more and more
and more gallons. And you might say,
hey, well why don't I just keep producing
more and more units? Why don't I go here and maybe
I 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
those incremental units that you're producing
beyond the 8,000, you're losing money on those. That 8,000 in 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 loss. It'll start going at a negative
240 something, negative 250, and so forth and so one. So you still don't want to
produce beyond that point. And we'll touch more deeply
on it 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 equivalent
to our marginal cost. But over the long-run, maybe
our fixed items, our capital, our machinery wears off or maybe
the contract for my employees wear off, and then we
have a different cost structure over the long-term. But 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 a $240 per week loss as opposed to just
producing nothing and taking $1,000 per week loss. Now it might not be rational
once these things have been worn out-- your robots
and the employees' contracts. It might not be rational to
continue them past their term. And we'll think about that
more because obviously, we are running at a loss. This is not necessarily
a good business to be in, but now that we've
gotten into 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
$1,000 per week loss. Anyway, see you
in the next video.