Understanding Marginal revenue and marginal cost are essential for businesses since it helps companies maximize and analyze the profits they incur. These two put together and helps to determine the number of units of a service or product a business should produce along with the needed price per unit. Here are some explanations of the two terms:
It is the increase attributed to income which is generated by selling off an extra additional unit of any service or good. This sum is calculated by just dividing up the change witnessed in the total revenue with the variation found in the total number of units being sold. This change in the total revenue is then calculated using subtracting the sum of revenue, which was there before the absolute last unit was sold off from the total income after it was put in the market for selling.
Marginal cost, on the other hand, is just the increase found in the value which a business incurs while producing only one extra unit of any service or product. Marginal cost can be seen by taking into account the change found in price and then dividing it up by the change observed in quantity.
When business output increases
If a business's marginal revenue is found to be less than its minimal cost which is incurred when manufacturing more units, then it is a just indication that the business is making more. But if it is found that the business's marginal revenue is higher than what its marginal cost is then it is a sign of the company not manufacturing enough units. The ideal situation is of course when a business's marginal revenue equals its minimal cost because then it is in the best possible position to fully maximize its profits.
What happens when marginal revenue starts falling?
When marginal revenue starts falling, then a business should prepare to take a much closer look at the cause behind it because it can arise due to the variety of reasons ranging from price wars to market saturation. In such cases, the business can hit back by allocating funds towards the research and development department so that they are always in tune with what the market wants. If the company can't increase its marginal revenue after being in decline, then it may be suitable to maintain sales where they intersect.
Any rational business or company will always look for maximizing its profits because this relationship between marginal cost and marginal revenue will help them in finding this.
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