Marginal revenue below average total cost | Microeconomics | Khan Academy

published on July 20, 2020

In the last video we finished up asking ourselves what how much do we produce if the market price if the market price is at forty five cents and just going with the logic that we introduced in the last video you want to produce as much as possible to to spread out the fixed cost

But you don't want to produce so much that the marginal cost is higher than your marginal revenue and your marginal revenue is your market price every unit every incremental unit you're going to get 45 cents so you want to look at the

Quantity where your marginal revenue the forty-five cents is equal to your marginal cost so we could look at it over here so if we look at our marginal revenue so it's Ford let's say 45 cents is right over there

You want to look where the forty-five cents is equal to your marginal cost and it looks like it is right over there now we can even see it on our table when does our marginal cost equal forty-five cents it equals that when we produce

Eight thousand gallons of our Juice when we produce eight thousand gallons of our Juice now the reason why this is somewhat interesting is at that point the amount of revenue that we're getting per unit our marginal revenue is less

Than our total costs per unit our total cost we're selling each unit at forty five cents but our total costs for each of those units is forty eight cents on average so this right over here is our total cost so you might say look I'm

Making a loss on every unit the total amount of revenue I'm getting is a smaller rectangle over here it's the quantity times the marginal revenue per unit so this is the amount of revenue that I'm getting let me color it in

Carefully that is the amount of revenue that I'm getting while my costs are this larger rectangle my quantity my quantity times my to my average total cost per unit and so what I end up with is if you take that if you take that revenue and

You subtract out that quantity you end up with a loss of exactly this much you end up you are operating in this situation at a loss you're operating at a loss when you are producing 8,000 units at four and you're getting 45

Per unit so does it make sense for you to do this and we can even figure out the loss you are producing 8000 units and you're selling them for 45 cents a unit and it costs you 48 cents per unit to produce them on average when you put

All the costs in 48 cents per unit so you are losing 3 cents per unit losing 3 cents 3 cents per I guess gallon we're talking about orange juice here and it's times 8,000 gallons times 8,000 gallons means

That we are losing we are losing 240 dollars 8,000 times 3 cents is 24,000 cents which is the same thing as 240 dollars so does it make sense for us to do this well one way to think about it let's say

We didn't do it let's say we're just we're like hey I'm not going to produce any gallons well then what's going to be our loss well we're assuming that this is our fixed cost we've already committed ourselves to this expenditure

Right over here whether we produce whether we produce no drops of orange juice we are still going to be spending a thousand dollars so if we produce nothing we are guaranteeing ourselves a weekly loss of a thousand dollars and so

This is at least better than that so by starting to produce some units we are at least able to offset some of that loss and we're spreading out that fixed cost over more and more and more gallons and you might say hey well why don't I

Just keep producing more and more units why don't I just why don't I go here maybe I produce 9,000 units where the marginal cost all of a sudden is higher than our marginal revenue and the reason why that won't make any sense to do is

Because if you produce that many units then all of a sudden each of those incremental units that you're producing beyond the 8,000 you're losing money on those that 8,000 and first unit the marginal cost is going to be higher than

The marginal revenue that you're bringing in on that unit so you're going to be losing money you're going to start having you're going to start having a lower profit than even the negative 240 dollar loss it'll start going you know

To negative 240 something negative 250 and so forth and so on so you still don't want to produce beyond that point and we'll touch more deeply on it in future videos but this is this is essentially what differentiates the

Short-term supply curve from long run supply curve in the in the in the short term we're going to assume that we have these fixed costs and so it's just going to make sense to produce equivalent to our marginal cost but over

The long run over the long run maybe our fixed our fixed items our capital our machinery wears off or maybe then the contract for my employees wear off and then we have a different cost structure over the fit over the long term but

We'll think about that in another video but the simple answer is assuming these really are your fixed costs you still want to produce as many units as possible so that your so that your marginal costs or is equal to your

Marginal revenue which in this case is the market price we are price takers so it actually is a rational thing to produce 8,000 units and take a loss on that and take a 240 dollar per week loss as opposed to as opposed to just

Producing nothing and taking \$1,000 per week loss now it might not be rational once these things have been worn out that your robots and your employees contracts it might not be rational to continue them past their term and we'll

Think about that more in another it because obviously we are running at a loss and this is not necessarily a good business to be in but now that we've gotten into the business we might as well stay in it in order to recoup some

Of our costs here or at least spread them out or at least make not have \$1,000 per week a loss anyway see you the next video

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