# Marginal Revenue_ Marginal Cost_ Supply and Demand - PowerPoint

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```					Marginal Revenue, Marginal
Cost, Supply and Demand
Scenario
• Here is the supply and demand at various
prices for product X

Price     Demand    Supply
\$1        9         5
\$2        8         6
\$3        7         7
\$4        6         8
Graph
• Here is what the supply and demand graph look
like – what is equilibrium?

\$5
\$4
\$4
\$3
Price

\$3                                       Demand
\$2                                       Supply
\$2
\$1
\$1
\$0
4   5   6      7       8   9   10
Quantity
Costs
• Now, here are the total, fixed and variable costs
at each point on the supply curve

Supply    Total     Variable   Fixed
Cost      Cost       Cost
5         15        5          10
6         17        7          10
7         20        10         10
8         24        14         10
Marginal Revenue and Marginal
Cost
Price    Quantity    Total    Marginal     Units    Variable   Fixed   Total   Marginal   Profit
Sold      Revenue   Revenue    Supplied    Cost      Cost    Cost     Cost
(demand)                         (supply)

\$1         9         \$9                    5         \$5        \$10     \$15                (\$6)

\$2         8        \$16        \$7          6         \$7        \$10     \$17      \$2        (\$1)

\$3         7        \$21        \$5          7        \$10        \$10     \$20      \$3        \$1

\$4         6        \$24        \$3          8        \$14        \$10     \$24      \$4        \$0

As you can see, at a Price of \$3 MR>MC, and at a Price of \$4, MC>MR.
Therefore the profit maximization point (mr=mc) is somewhere between \$3 and
\$4 – let varify it visually!
Visually
8
7
6
Price (cost)

Marginal Revenue
5
Marginal Cost
4
Demand
3
2                                              Supply
1
0
0   1   2   3   4   5   6   7   8   9 10
Quantity

As you can see, the equilibrium of supply and demand is at a quantity of 7 and a price of
\$3 (in this case, supply = marginal cost) – the Profit maximization point (where marginal
revenue reaches and equals marginal cost) is close to a quatity of 8 and price of \$3.50.
However, since we are dealing with whole dollars, the best we can do is the equilibrium
• When economist look at costs, they also
look at average costs
– Average total costs
• The total cost divided by the units of output
– Average fixed costs
• The Fixed cost divided by the units of output
– Average variable costs
• The Variable cost divided by the units of output
In this example
Units     Variable    Average    Fixed   Average   Total   Average
Supplied    Cost       Variable   Cost     Fixed    Cost     Total
Cost               Costs             Cost

(supply)

5         \$5         \$1.00     \$10      \$2.00    \$15      \$3.00

6         \$7         \$1.17     \$10      \$1.67    \$17      \$2.83

7         \$10        \$1.43     \$10      \$1.43    \$20      \$2.86

8         \$14        \$1.75     \$10      \$1.25    \$24      \$3.00
Visually
4.5
4                              Marginal Cost
3.5
Price (cost)

3                              Average Total Cost
2.5
2                              Average Variable
1.5                              Cost
1                              Average Fixed
0.5                              Costs
0
4   5   6     7    8   9
Quantity

This graph shows us that when the marginal cost, or next unit cost is below the average
total cost, the average cost decreases. When marginal cost goes above average cost,
the average cost begins to increase.
Why does the average variable increase? Why does the average fixed cost decrease?
What is happening to the average total cost? Why?
So what?
• Take a look at this graph, showing the cost
curves from the previous graph with the
marginal revenue, supply and demand.
\$8
\$7
\$6
Price (Cost)

\$5                                       Demand
\$4
Supply
\$3
Marginal Revenue
\$2
\$1                                       Marginal Cost
\$0                                       Average variable cost
5   6   7              8   9   10   Average Fixed Costs
Quantity                Average Total Cost
•              Study this graph for ten minutes, and answer the tough questions on the next slide

\$8
\$7
\$6
Price (Cost)

\$5                                                                       Demand
\$4
Supply
\$3
Marginal Revenue
\$2
\$1                                                                       Marginal Cost
\$0                                                                       Average variable cost
5         6          7              8       9          10           Average Fixed Costs
Quantity                                   Average Total Cost
1. What is the equilibrium profit?
2. What is the profit maximization price and quantity, and what is the profit at
that point?
3. Why does the average total cost begin to rise at a quantity of 7?
4. Draw out the average variable, fixed and total costs, as well as marginal
revenue to a quantity of ten. What does it mean when each line is crossed?
At which corssings should production continue? At which crossings should
production not continue?
Now you try…
• With your group, graph the following
information (on the next slide) and find:
– The profit maximization point
– The equilibrium profit
– The point at which the firms should continue
is the short run
– The point at which the firms should not
continue in the short run
P    D    R   MR    S     VC     AVC     FC    AFC     TC   ATC   MC

\$1   24             5      \$2           \$12

\$2   19             6      \$4           \$12

\$3   13             7      \$7           \$12

\$4   6              8     \$11           \$12

Fill in the blanks above, then graph…

```
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