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Profit Maximization: Marginal and Average Revenue

Here are some intro explanations and examples of microeconomic principles behind profit maximization, marginal, and average revenue. In our examples we will make some assumption in perfect competition scenario.

Assumptions of perfect competition:

  • Homogeneous product
  • Perfect information
  • many buyers and sellers
  • No barriers to entry or exit

Perfect Competition Note

Given the above assumptions, no individual firm can influence the price of the product since their output represents an extremely small portion of the total output. Firms are said to be price-takers.

Revenues: Total Revenue (TR) = Price * Quantity

Marginal & Average Revenue

From this total revenue, we can derive:

1. Marginal Revenue: change in total revenue as a result of a 1-unit change in output. (Also the slope of the TR curve).
2. Average Revenue: Total revenue divided by total output. Can also be calculated by taking the slope of a ray from the origin and touching any point on the TR curve. But this ray is simply the TR curve itself and we have calculated this slope as P*!

Costs of the Firm

What does the total cost curve look like? We need to address the issue of marginal returns over the possible output produced.

PROFITS : What will be thr profit-maximizing output?

Answer: it will lie (if you wanted to graph it you could), between Qo and Q1. Intuitively, if an additional unity adds more to revenues (MR) than it does to costs (MC), we should go ahead and produce this unit.
Continue in this fashion until: MR = MC

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