Civil Engineering Reference
In-Depth Information
Marginal Analysis
Another way to find the profit-maximising rate of production for a firm is by
marginal analysis. This method involves making a detailed study of marginal
revenue and marginal costs. The concept of
marginal cost
has already been
introduced in
Chapter 7
. It was defined as the change in total cost due to a one-
unit change in production. The resulting schedule of costs was based on the law
of diminishing returns: at first costs fall and then they begin to rise. Some example
calculations for a marginal cost schedule were presented in column 4 of
Table 7.3
.
This leaves
marginal revenue
to be clarified.
Marginal Revenue
Marginal revenue represents the increment in total revenue attributable to selling
one additional unit of product. For example, if selling an extra unit of construction
activity increases a contractor's total revenue from £1,800 to £2,100, the marginal
revenue equals £300. Hence, marginal revenue may be calculated by using the
formula:
change in total revenue
change in output
marginal revenue =
In any market structure, therefore, marginal revenue is closely related to price.
In fact in a perfectly competitive market, the marginal revenue curve is exactly
equivalent to the price line or, in other words, to the individual firm's demand curve,
since the firm can sell all of its output (including the last unit of output) at the
market price.
COMPARING MARGINAL COST WITH MARGINAL REVENUE
Obviously, if the marginal revenue from a unit increase in output is greater than
the marginal cost, it would seem rational for the profit-maximising firm to produce
that unit of output. Conversely, if the marginal cost of an extra unit of output
exceeds its marginal revenue, it would be produced at a loss and, therefore, it
would be inappropriate for the profit-maximising producer to produce that unit of
output. In fact, all firms have a clear incentive to produce and sell right up to the
point at which the revenue received from selling one more unit of output equals the
additional cost incurred in producing that unit. If the firm chooses to stop output
before this point, it will not have maximised profits: it will not have squeezed the
pips until they squeak. The profit maximiser should not be satisfied until the last
penny of profit has been earned. This will only be achieved at the point where
marginal costs equal marginal revenue. This decision rule is represented by point E
in
Figure 8.3
(see page 128).
