Marginal revenue and Marginal cost approach

The second method of showing equilibrium of the firm is in terms of marginal revenue and marginal cost curves.

There are three condition that must be satisfied for the profits to be maximum.

Rule 1 :

In the short run, a firm should produce 

if and only if P or AR > AVC  OR TR > TVC

1) A firm has to incur fixed cost even if there is no production, firm sometimes continues to produce even when it is facing losses.

If a firm decides to shut down and produce nothing, the losses would be equal to its fixed cost.

2) A profit earning firm will never lose more than its fixed cost, if the revenue is so low that the firm is unable cover its variable cost, to avoid this cost a firm can stop (cease) production, but if the firm still has the capital to resume production later, 

so this is a situation of Shut down ( a firm produce no output to minimise its lose).

Relation between average cost and marginal cost

There is an important relation between the average cost and marginal cost curves. The relation is shown in table and in graph.

Tabular representation

Units of Output	Total Cost	Marginal Cost	Average cost AC = TC / Q
0 1 2 3 4 5 6 7 8	10 20 28 34 38 42 48 56 72	- 10 8 6 4 4 6 8 16	∞ 20 14 11.3 9.5 8.4 8 8 9

Graphical representation

average cost

From the above table and graph following observations can be made between AC and MC

Marginal Cost

Marginal cost is the change in total cost when additional unit of output is produced.

As said by Ferguson “Marginal cost is the addition to total cost due to the addition of one unit of output.”

Symbolically,

MC_n = TC_n – TC_n-1 OR

MC = Change in total cost / Change in output

MC_n = Marginal cost of ‘n’ units of output

TCn = Total cost of ‘n’ units of output

TC_n-1 = Total cost of ‘n-1’ units of output

Tabular representation of calculating MC

Units of Output	Total Fixed        Cost	Total  Variable         Cost	Total Cost	Marginal Cost
0 1 2 3 4 5 6 7 8	10 10 10 10 10 10 10 10 10	0 10 18 24 28 32 38 46 62	10 20 28 34 38 42 48 56 72	- 10 8 6 4 4 6 8 16