Marginal revenue below average total cost

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Marginal revenue below average total cost발음듣기

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In the last video, we finished up asking ourselves, how much do we produce if the market price is at $0.45?발음듣기

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And just going with the logic that we introduced in the last video, you want to produce as much as possible to spread out the fixed cost.발음듣기

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But you don't want to produce so much that the marginal cost is higher than your marginal revenue.발음듣기

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And your marginal revenue is your market price.발음듣기

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Every unit, every incremental unit, you're going to get $0.45.발음듣기

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So you want to look at the quantity where your marginal revenue, the $0.45, is equal to your marginal cost.발음듣기

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So we could look at it over here.발음듣기

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So if we look at our marginal revenue, let's say $0.45 is right over there.발음듣기

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You want to look where the $0.45 is equal to your marginal cost.발음듣기

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And it looks like it is right over there.발음듣기

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Now we could even see it on our table.발음듣기

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When does our marginal cost equal $0.45?발음듣기

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It equals that when we produce 8,000 gallons of our juice.발음듣기

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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 cost per unit.발음듣기

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We're selling each unit at $0.45, but our total cost for each of those units is $0.48 on average.발음듣기

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So this right over here is our total cost.발음듣기

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So you might say, look, I'm making a loss on every unit.발음듣기

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The total amount of revenue I'm getting is a smaller rectangle over here.발음듣기

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It's the quantity times the marginal revenue per unit.발음듣기

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So this is the amount of revenue that I'm getting.발음듣기

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Let me color it in carefully.발음듣기

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That is the amount of revenue that I'm getting.발음듣기

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While my costs are this larger rectangle.발음듣기

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My quantity times my average total cost per unit.발음듣기

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And so what I end up with is if you take that revenue and you subtract out that quantity, you end up with a loss of exactly this much.발음듣기

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You are operating, in this situation, at a loss.발음듣기

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You're operating at a loss when you are producing 8,000 units and you're getting $0.45 per unit.발음듣기

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So does it make sense for you to do this?발음듣기

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And we can even figure out the loss.발음듣기

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You are producing 8,000 units.발음듣기

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You're selling them for $0.45 a unit.발음듣기

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And it costs you $0.48 per unit to produce them on average when you put all the costs in, $0.48 cents per unit.발음듣기

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So you are losing $0.03 per unit, I guess gallon.발음듣기

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We're talking about orange juice here.발음듣기

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And it's times 8,000 gallons, means that we are losing we are losing $240.발음듣기

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8,000 times $0.06 is 24,000 cents, which is the same thing as $240.발음듣기

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So does it make sense for us to do this?발음듣기

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Well, one way to think about it, let's say we didn't do it.발음듣기

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Let's say we're like, hey, I'm not going to produce any gallons.발음듣기

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Well then what's going to be our loss?발음듣기

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Well, we're assuming that this is our fixed cost.발음듣기

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We've already committed ourselves to this expenditure right over here.발음듣기

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Whether we produce no drops of orange juice, we are still going to be spending $1,000.발음듣기

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So if we produce nothing, we are guaranteeing ourselves a weekly loss of $1,000.발음듣기

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And so this is at least better than that.발음듣기

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So by starting to produce some units, we are at least able to offset some of that loss.발음듣기

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And we're spreading out that fixed costs over more and more and more gallons.발음듣기

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And you might say, hey, well why don't I just keep producing more and more units?발음듣기

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Why don't I go here and maybe I produce 9,000 units where the marginal cost all of a sudden is higher than our marginal revenue?발음듣기

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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.발음듣기

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That 8,000 in first unit, the marginal cost is going to be higher than the marginal revenue that you're bringing in on that unit.발음듣기

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So you're going to be losing money.발음듣기

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You're going to start having a lower profit than even the negative $240 loss.발음듣기

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It'll start going at a negative 240 something, negative 250, and so forth and so one.발음듣기

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So you still don't want to produce beyond that point.발음듣기

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And we'll touch more deeply on it in future videos, but this is essentially what differentiates the short-term supply curve from the long-run supply curve.발음듣기

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In the short-term, we're going to assume that we have these fixed costs.발음듣기

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And so it's just going to make sense to produce equivalent to our marginal cost.발음듣기

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But over the long-run, maybe our fixed items, our capital, our machinery wears off or maybe the contract for my employees wear off, and then we have a different cost structure over the long-term.발음듣기

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But we'll think about that in another video.발음듣기

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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 marginal cost is equal to your marginal revenue, which in this case is the market price.발음듣기

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We are price takers.발음듣기

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So it actually is a rational thing to produce 8,000 units and take a loss on that and take a $240 per week loss as opposed to just producing nothing and taking $1,000 per week loss.발음듣기

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Now it might not be rational once these things have been worn out - your robots and the employees' contracts.발음듣기

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It might not be rational to continue them past their term.발음듣기

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And we'll think about that more because obviously, we are running at a loss.발음듣기

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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 not have $1,000 per week loss.발음듣기

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Anyway, see you in the next video.발음듣기

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