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Marginal revenue below average total cost

People sometimes assume that a firm that isn't earning a profit should immediately shut down. In this video, we explore why that might not actually be a very good idea, and why it might be rational to produce at a loss. Created by Sal Khan.

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• How is it a 1000\$ per week loss. Coz fixed cost is only one time. So if we produce for more than a month we would actually lose more money??
• Fixed costs don't mean one time; it means they don't vary with output (so it's always \$1000 no matter how much orange juice—including none—is produced).

Yes, if you continued to produce based on this data you would keep losing money. However, as Sal says, you are better off producing where MR=MC because P is greater than AVC, which means you are covering at least some of your fixed costs. If you produce there, you lose \$240 per week, but if you shut down you lose \$1000 per week (since you still owe the fixed cost no matter what). Obviously, it's better to produce.

Here's another way to think about it. You buy a car to drive to work. The car costs \$100 per month, gas to work and back costs \$50 per month, and your job pays \$125 per month. The car is a fixed cost—you pay it no matter how much (or little) you drive. The gas is a variable cost—you pay it based on how much you drive. It's \$50 if you go to work each month, and \$0 if you don't.

You might think, "I'm losing money by going to work, so I may as well not go!" Sure enough, you are losing \$25 per month. However, although you would save \$50 in gas by not going to work, you would also lose the \$125 income that was paying for the gas and some of the car payment. By not going to work, you are now losing \$100 per month (you still pay for the car).

Hope that helps.
• Incase the market price is below the ATC, won't you losses will be minimum (area of the rectangle Units*(ATC-MP) ) when ATC is minimum? So shouldn't ATC be used to determine the quantity to be produced over MC in case of loss?
• If you produced at the point where ATC is at a minimum, then your marginal cost would be higher than your marginal revenue. If this was the case then you would be making negative profit on every gallon you sold over 8000 dollars, so although your total costs would be lower, you would be making more of a loss due to MC being higher than MR. Sal covers this at the end of this video if you listen again :)
• Why does Marginal Cost = Marginal Revenue?
(1 vote)
• It's not the fact that they're equal, but where they are equal that is important.

That is, where MR = MC is the quantity where profit is maximized.
• I'm lost at . Didn't we learn in the last video that 9000 was the ideal quantity to produce?
(1 vote)
• In the beginning of the previous and this video there are two assumptions made:
- in the previous video it is assumed that the price is 0.5 dollar / gallon
- in this video it is assumed that the price is 0.45 dollar / gallon

The decrease of the price was made to demostrate how the orange producer suffers a loss, but still in the short run, it is worth still running the company.
See, no reason to be lost :)
• Why is it that you're maximizing profits where marginal revenue equals marginal cost, wouldn't you be making more money if your marginal revenue was above marginal cost? Thanks.
(1 vote)
• No. Marginal revenue is the amount of money you get from selling the next incremental unit. Marginal cost is the amount of money you pay to make the next incremental unit. If marginal revenue were greater than marginal cost, than that means you could make more money by selling the next incremental unit. That means that you haven't maximized your profit yet.
• when mc is equal to mr, the producer will make no profit. right?
i mean ,i don't understand why there is not a MR curve which make it more clear.
shouldn't the profit is the area below MR curve
• When we say MC=MR, we are normally talking about the single point at which they intersect. We are not saying that MC(Q)=MR(Q) for all Q. The profit is the area between the MR curve and the MC curve. The point at which they intersect is the point at which that area is maximized.
• When there is a negative profit or loss, is it a negative economic profit or a negative accounting profit?
• In this case, the negative 240 dollars is a negative accounting profit as opportunity costs haven't been take into consideration.
(1 vote)
• I've been told that it costs 1.8 cents to produce a U.S. penny. I have never completely understood why pennies are still being made in the U.S., but does this same reasoning apply in that scenario? That MC must equal MR, otherwise there would be that loss of \$1000 (or whatever amount that would be substituted in for this example)? Or is this specifically only for the short-term, in order to cut losses until a more permanent solution is made?
• The marginal revenue from making 1 penny is 1¢, no more or less. If the marginal cost of making a penny is 1.8¢, then it is clearly unprofitable for the US Treasury to make pennies. However, governments aren't known for doing things profitably.
• So what happens when Average variable cost is higher than the Marginal cost?

On a side note, what's a simple way to remember what the variable cost is?
• If AVC is higher than MC, production should stop because revenue does not cover fixed or variable cost. Variable cost is total cost - fixed cost.
• When MR = MC are you not only breaking even? I'm confused, how do you maximize profit when breaking even? Or is it the point where the maximum amount of profit has been made and no more profit is possible?
• When Marginal Revenue equals Marginal Cost, you have made the maximum amount of profit possible. That is what it means to maximize profit. The actual profit you get might be anything; it can even be negative, but the point at which marginal revenue equals marginal cost is the best you can do for yourself.