We can now represent the profit maximisation position of Funky Chicken graphically. For this purpose, we will only use the quantity, marginal revenue and marginal cost data as indicated in the table below.
Consider an output level of 90 in the following diagram:
- What is the marginal revenue at this output level?
- What is the marginal cost at this output level?
- Should the firm increase or decrease its production?
Levels of output to the right of 80, where MR < MC, indicate that marginal revenue is less than marginal cost, and it is in the interest of the firm to decrease its production in order to increase its profits.
Levels of output to the left of 80, where MR > MC, indicate that marginal revenue is greater than marginal cost, and it is in the interest of the firm to increase its production in order to increase its profits.
To summarise, we can conclude the following:
The firm maximises profits if it produces the quantity where the marginal revenue (MR) is equal to the marginal cost (MC).
If MR = MC, then there is profit maximisation.
If MR > MC, then profits increase.
The reason for this is straightforward. For as long as the marginal revenue is greater than the marginal cost, the marginal revenue contributes towards total profits. By producing and selling an additional unit, the producer gains more than it costs to produce the additional unit, and its profits increase.
If MR < MC, then profits decrease.
When marginal revenue is less than marginal cost, total profits will decline. It is costing the firm more to produce the additional unit than it obtains from selling the additional unit. It is therefore not in the interest of the firm to produce the extra unit because this decreases its profits.
Each graph indicates the output which the ice cream factory is currently producing. Based on the following graphs, what should the firm do to its output in each instance if it wishes to maximise its profits?