Let's continue with our

orange juice producing example

In this situation I want to think about

what a rational quantity of orange juice might be

what would be a rational quantity

of orange juice to produce

given a market price

So let's say that

the market price right now is

50 cents a gallon

and I'm going to assume that

there are many producers here

so we're going to have to be price takers

and obviously we want to charge

as much as we can per gallon

but if we charge even a penny

over 50 cents a gallon

then people are going to buy

all of their orange juice

from other people

so this is the price that we can charge

50 cents per gallon

So, if we think about it

in terms of marginal revenue

per incremental gallon

well that first incremental gallon

we're going to get 50 cents

the next incremental gallon

we're going to get 50 cents for that one

and the next one

we're going to get 50 cents as well.

for the first thousand gallons

we're going to get 50 cents

for each of those gallons

for the first 10 thousand gallons

we'll get 50 cents per gallon

So, our marginal revenue curve

will look something like this

Our marginal revenue is a flat curve

right at 50 cents a gallon

so that is our marginal revenue

at 50 cents

at a market price of 50 cents per gallon

now in this situation

what's a reasonable quantity

that we would want to produce?

Now there's two dynamics here

we want to produce as much as possible

so that we can spread our fixed cost

over those gallons

that's one way of thinking about it

or, another way of thinking about it is

we have a certain amount of fixed cost

we are spending $1000 no matter what

so why don't we try to get

as much revenue as possible

to try to make up for those fixed costs

or if we think about it

in terms of average fixed cost

the more quantity that we produce

the component of the cost for that

from the fixed cost

goes down and down and down

so we want to have as much as possible

to spread our fixed costs

now the one thing that we do need to think about is

especially once we kind of get beyond the little dip

in the marginal cost curve

and as we produce more and more units

the marginal cost is going up higher and higher and higher

we don't want to produce so much

that the cost of producing that incremental unit

the marginal cost of that incremental unit

is more than the marginal cost of that actual

or the marginal cost of that incremental unit

is not higher than the marginal revenue

that we're getting on that incremental unit

so, until marginal revenue is equal to marginal cost

or another way to think about it

you don't want marginal cost

and this is after we go to this little dip here

we're trying to do as much as possible

marginal cost is going higher and higher and higher

we don't want to produce this much right over here

because here the cost for that extra gallon is higher

than what we're going to get for that extra gallon

looks like that cost for that extra gallon

might be 53 cents

while we're only gonna get 50 cents

for that extra gallon

so every extra gallon we produce over here

we're going to be losing money

so you don't want marginal cost

to be greater than marginal revenue

so when you look at the curves like this

and make sense to just say

when does marginal revenue equal marginal cost?

and that's this point right over here

and that is the rational amount to produce

so that is 9000 units

so we're going to be at this line over here

we're gonna produce 9000 gallons of juice

our revenue that we're going to get

is going to be the rectangle of the area

that is high as the price we're getting per unit

times the number of units

so this is gonna be the total revenue we get

if we were to shade this in

I'm not gonna shade this in

because it's going to make my whole diagram messy

and what's our total cost?

well, we have our average total cost right here

this is our average total cost at 48 cents

that's the little green triangle here

so it's 48 cents per unit

times the total number of units

our cost, the area in this rectangle

so if I were to shade this in

this little slightly smaller rectangle

and so our profits are the difference between the two

our total revenue is the area under the rectangle

that has this marginal revenue line as its upper bound

and our cost is the rectangle

that has our average total cost

this line right over here

as its upper bound

so our profits in this circumstance

are going to be the area right over here

the height is the difference between our marginal cost

which is the same as our marginal revenue

and our total cost

so the heigh is going to be

this two cents right over here

we're taking the difference of 50 and 48

so it's gonna be 2 cents

and then, the quantity produced

is going to be 9000 units

so 9000

we're making 2 cents per unit

remember, our average cost

our average total cost is 48 cents per unit

we're selling that 50 cents per unit

so we're making 2 cents per unit

that's not 20

we're making 2 cents per unit

2 cents times 9000 units gives us

that's 18000 cents, or 180 dollars of profit

now what I want you to think about

and we'll answer this in the next video

is does it make sense to sell units at all

and if so, how many units should we sell

if, and here is the question

if the market price is lower

than your average total cost

so does it make sense

and how many units does it make sense to produce

let's say if the market price were 45 cents per unit

here i would like to make a relation ship between Marginal Revenue and Marginal Cost,,, The marginal cost of production measures the change in total cost of a good that arises from producing one additional unit of that good. The marginal cost is calculated by dividing the change in the total cost by the change in quantity. Using calculus, the marginal cost is calculated by taking the first derivative of the total cost function with respect to the quantity: MC = dTC/dQ. For example, the total cost of producing 100 units of a good is $200. The total cost of producing 101 units is $204. The average cost of producing 100 units is $2, or $200/100; however, the marginal cost for producing the 101st unit is $4, or ($204 - $200)/(101-100). The marginal revenue measures the change in the revenue that arises when one additional unit of a product is sold. The marginal revenue is calculated by dividing the change in the total revenue by the change in the quantity. In calculus terms, the marginal revenue is the first derivative of the total revenue function with respect to the quantity: MR = dTR/dQ. For example, suppose the price of a product is $10 and a company produces 20 units per day. The total revenue is calculated by multiplying the price by the quantity produced. In this case, the total revenue is $200, or $10*20. The total revenue from producing 21 units is $205. The marginal revenue is calculated as $5, or ($205 - $200)/(21-20). When marginal revenue and the marginal cost of production is equal, profit is maximized at that level of output and price. In terms of calculus, the relationship is stated as: dTR/dQ = dTC/dQ When marginal revenue is less than the marginal cost of production, a company is producing too much and should decrease its quantity supplied until marginal revenue equals the marginal cost of production. When the marginal revenue is greater than the marginal cost, the firm is not producing enough goods and should increase its output until profit is maximized. Read more: How is marginal revenue related to the marginal cost of production? | Investopedia http://www.investopedia.com/ask/answers/041315/how-marginal-revenue-related-marginal-cost-production.asp#ixzz3vHDSNM4E Follow us: Investopedia on Facebook