David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

6.6 Marginal cost and marginal revenue
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Marginal revenue is the increase in the
firm's revenue from on increase in soles
by one unit. If the firm con sell more output
only by reducing its price, marginal revenue
declines as output rises.
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0 2 3 4 5 6 7 8 9 10
Output
Figure 6.2
Marginal revenue
Marginal revenue falls steadily for two reasons. First, because demand curves slope down, the extra unit
must be sold at a lower price. Second, successive price reductions reduce the revenue earned from existing
units of output, and at larger output there are more existing units on which revenue is lost when prices
fall further. To sum up, (a) marginal revenue falls as output rises and (b) marginal revenue is less than the
price for which the last unit is sold, because a lower price reduces revenue earned from existing output (see
Maths 6.1).
MR, MC and the output choice
Combining marginal cost (MC) and marginal revenue (MR), Table 6.6 examines the output that maximizes
the firm's profits. If MR exceeds MC, a I-unit increase in output will increase profits. The last column
shows that this reasoning leads the firm to make at least 6 units of output. The firm now considers increasing
output from 6 to 7 units. Marginal revenue is £9 and marginal cost £12. Profits fall by £3. Output should
not be expanded to 7 units, or to any level above this.
The firm should expand up to 6 units of output but no further. This output maximizes profits, as we know
already from Table 6.5.
Table 6.3, based on total cost and total revenue, and Table 6.6, based on marginal cost and marginal
revenue, are different ways to study the same problem. Economists frequently use marginal analysis. Is
there a small change that could make the firm better off? If so, the current position cannot be the best
possible one and changes should be made.
Marginal analysis should be subjected to one very important check. It may miss an all-or-nothing choice.
For example, suppose that MR exceeds MC up to an output level of 6 units but thereafter MR is less than
MC. Six units is the best positive output level. However, if the firm incurs large costs whether or not it
produces (for example, a vastly overpaid managing director), the profit earned from producing 6 units
may not cover these fixed costs. Conditional on paying these fixed costs, an output level of 6 units is then
the loss-minimizing output level. Shareholders might do better to shut the firm and fire the fat cat boss. We
examine this issue in the next chapter.
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