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

6. 7 Marginal cost and marginal revenue curves
Changes in cost
Suppose the firm faces a price rise for a raw material. At each output, marginal cost is higher than before.
Figure 6.4 shows this upward shift from MC to MC'. The firm now produces at E'. Higher marginal costs
reduce profit-maximizing output from 01 to 02•
A demand shift
Suppose the firm's demand curve shifts up, for example because the good produced by the firm becomes
more popular and so more consumers want to buy it. If the demand shifts up, the marginal revenue curve
must also shift up. At each output, price and marginal revenue are higher than before. In Figure 6.5 the MR
curve shifts up to MR', inducing the firm to move from E to E'. Higher demand makes the firm expand
output from 01 to 03• Notice that, as the demand increases, so too does the price at which the firm can sell
each level of output. Figure 6.4 shows us that a profit-maximizing firm will respond to this increase in the
price by increasing the output produced, a result that is consistent with the idea that a supply curve should
be positively sloped, as discussed in Chapter 3.
Do firms know their marginal cost and marginal revenue curves?
Do firms in the real world know their marginal cost and marginal revenue curves, let alone go through
some sophisticated calculations to make sure output is chosen to equate the two?
Such thought experiments by firms are not necessary for the relevance of our model of supply. If, by luck,
hunch or judgement, a firm succeeds in maximizing profits, marginal cost and marginal revenue must be
equal. Our formal analysis merely tracks the hunches of smart managers who get things right and survive
in a tough business world.
In this chapter we introduced cost and revenue conditions and the idea of profit maximization. Later chapters
fill in the details but we now have the basis for a theory of how much output firms choose to supply. Firms
choose the level of output that maximizes profits. At this level of output, marginal cost equals marginal
revenue.
0
c
·-
E>
0
The marginal cost curve shifts up from MC to
MC as a result of an increase in the costs of
using a factor of production; for instance, the
wage may have risen. This upward shift moves
the intersection of MC and MR curves from E
to E'. Output falls from 01 to 02• Thus, when
the firm's costs rise, it decides to produce less.
0
Figure 6.4
An increase in marginal cost reduces output
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