Marginal Analysis
Managers, business owners as well as aspiring entrepreneurs should know the most appropriate business form or organization to adopt basing on the various considerations such as liability, taxes, profit sharing, capital contributions, asset ownership and losses, survivorship, management and control. These are the factors that determine whether a business organization becomes successful or fails.
Marginal revenue is the resultant increase in total revenue when an additional unit of output is sold. Marginal revenue can be found by calculating the quotient of the total change in revenue and the total change in the quantity of output. Therefore, we use total revenue to derive marginal revenue. Marginal revenue diminishes with the increase in output because of the law of diminishing returns. In a perfect competition setting, firms maximize their profits at the point where marginal revenue is equal to marginal cost.
Marginal cost is the resultant change in total cost when an additional product is made or produced. It is calculated by dividing the change in total cost by the change in quantity produced. The analysis of marginal cost is important in the determination of the point where economies of scale can be achieved in a company and the level of optimal production. The main objective of manufacturers is to analyze the costs that come with the addition of each production unit. It helps to avoid cases where production of extra units leads to very high costs hence reducing profits.
Profit is the financial benefit achieved when total revenues realized from a business activity is more than the total expenses, taxes and costs of sustaining the business. Therefore, profit is calculated by subtracting the total expenses or costs from the total revenues. Profit maximization is the effort of a business or company to attain the highest possible profit. Profit maximization involves various techniques which include; new market development, lean manufacturing, minimization of costs, flattening the organizational structure, reduction of wastes, reduction of labor costs, extending product lines, improving technology and increasing product profit margins through value maximization. In competitive firms, managers have to ensure total costs are as low as possible and total revenues are maximized so that profit can be maximized.
Profit maximizing companies can use their marginal revenues and costs to determine their levels of optimal production. Using marginal cost, the firms ensure that the marginal cost is kept as low as possible so that an additional product made leads to a very small increase in the total costs. Marginal revenues can be used to maximize profits by ensuring that every unit of the product made leads to a high increase in total revenues. This will be achieved using the various profit maximization techniques.
When the marginal revenue exceeds the marginal cost, the profit maximizing company will try to further increase the gap between the marginal costs and revenues by either increasing marginal revenue or reducing marginal cost to ensure profits are further maximized. Increasing marginal revenue means that the total revenues are increased while minimizing marginal cost means that the total revenues are reduced hence maximizing profits.
When the marginal costs in a firm exceed the marginal revenue, it implies that the company is likely to be making losses. A profit maximizing company will seek to reverse the situation by using the appropriate profit maximizing techniques such as adopting appropriate technology, cutting down on labor costs, adding value to the products so that the total costs are reduced while the total revenues are increased. In that situation, the marginal revenues will become greater than the marginal costs hence making the firm to maximize profits.
References
Carbaugh, R. J. (2010). Contemporary Economics: An Applications Approach (6, illustrated ed.). New York: M.E. Sharpe.
Mankiw, N. G. (2011). Principles of Economics (6 ed.). London: Cengage Learning.
