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Why marginal revenue equals marginal cost determines profit

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This Slideware explains to students in an AP Microeconomics class why marginal revenue equals marginal cost maximizes profit. Students seldom make this connection and just memorize the formula. This presentation makes teaching the concept easy.

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Why marginal revenue equals marginal cost determines profit

  1. 1. Why Marginal Revenue Equals Marginal Cost Determines Profit Maximization By Mike Fladlien Muscatine High School 1
  2. 2. Quantity Fixed Cost Variable Cost Total Cost Total Revenue Profit 0 1 0 1 0 -1.00Total Cost 0.25 1 0.02 1.02 0.3125 -0.70Fixed Cost (FC) – Constant Costs 0.5 1 0.06 1.06 0.625 -0.44regardless of output level 0.75 1 0.14 1.14 0.9375 -0.20 1 1 0.25 1.25 1.25 0.00Variable Cost (VC) – Costs that change 1.25 1 0.39 1.39 1.5625 0.17over output such as labor 1.5 1 0.56 1.56 1.875 0.31 1.75 1 0.77 1.77 2.1875 0.42Total Cost (TC) – The total of FC + VC 2 1 1.00 2.00 2.5 0.50 2.25 1 1.27 2.27 2.8125 0.55The Data 2.5 1 1.56 2.56 3.125 0.56 2.75 1 1.89 2.89 3.4375 0.55FC = $1 3 1 2.25 3.25 3.75 0.50 3.25 1 2.64 3.64 4.0625 0.42VC = .25Q^2 3.5 1 3.06 4.06 4.375 0.31 3.75 1 3.52 4.52 4.6875 0.17Profit is maxed at 2.5 units (the 4 1 4.00 5.00 5 0.00difference between total revenue and 4.25 1 4.52 5.52 5.3125 -0.20total cost is the greatest) 4.5 1 5.06 6.06 5.625 -0.44 2
  3. 3. The GraphProfit is maximized at 2.5 unitsNow, let’s show that at 2.5 units,marginal revenue equals marginal costMarginal Revenue – The change intotal revenue that results from sellingan addition unit of ouputMarginal Cost – The change in totalcost that results from a change inoutput. dTC/dQMarginal Cost (Calculus) is thederivative of the total cost function. Inthis case, .5Q 3
  4. 4. MR = MCThe slope of the TotalRevenue, TR, curve is the MarginalRevenue, MR.The Slope of the Total Cost, TC, curve isthe Marginal Cost curve.Let’s look at the slope of the TotalRevenue, TR, curve.The price of the product is $1.25Perfectly Competitive so the firm cansell all they want at $1.25Price Taker selling a homogenous goodwith many buyers and sellers 4
  5. 5. MR = MCSlope of TC is Marginal CostAt $1.25 the quantity is 2.5 5
  6. 6. MR = MCThe intersection of the MarginalRevenue and Marginal Cost curves isthe profit maximization point.Why?Because the distance between totalrevenue and total cost is the greatestat that point. 6
  7. 7. But Why Does This Work?When I show this to students, they stilldon’t get it.To convince your students that MR =MC maximizes profits, you have toshow that the slopes are equal.At 2.5 units the distance between thetwo curves is the farthest so profit ismaximized. 7
  8. 8. The Endwww.mikeroeconomics.blogspot.com 8

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