Marginal Cost vs Marginal Revenue
Marginal Cost and Marginal Revenue are related concepts in AP Economics that students often mix up. Marginal Cost is the additional cost incurred by producing one more unit of output. Marginal revenue is the additional revenue a firm earns from selling one more unit of output. Here is how they compare side by side.
It is calculated as the change in total cost divided by the change in quantity. Marginal cost typically decreases at first due to increasing marginal returns, then rises due to diminishing returns.
For a perfectly competitive firm, marginal revenue equals the market price because the firm is a price taker. For a price maker such as a monopoly, marginal revenue lies below price and falls faster than demand, because cutting price to sell one more unit lowers revenue on all prior units. Every firm maximizes profit where marginal revenue equals marginal cost.
Marginal Cost vs Marginal Revenue: The Profit-Maximising Rule
| Marginal cost | Marginal revenue | |
|---|---|---|
| Definition | The addition to total cost from one more unit | The addition to total revenue from one more unit |
| Formula | Change in total cost divided by change in quantity | Change in total revenue divided by change in quantity |
| Typical shape | U-shaped, falling while marginal returns are increasing and rising once diminishing marginal returns set in | Horizontal and equal to price in perfect competition, downward and below demand otherwise |
| What it depends on | Technology and input prices | The demand curve the firm faces |
| When MR exceeds MC | Produce more; each unit adds to profit | Produce more; each unit adds to profit |
| When MC exceeds MR | Produce less; each unit subtracts from profit | Produce less; each unit subtracts from profit |
One rule covers every market structure
Profit is maximised at the quantity where marginal revenue equals marginal cost, and this is true for a perfectly competitive farm, a monopoly, a monopolistically competitive restaurant, and an oligopolist. The logic is simple: while another unit brings in more than it costs, making it increases profit, so keep going. Once another unit costs more than it brings in, stop. The structure changes what marginal revenue looks like, not the rule. What differs is the second step. In perfect competition marginal revenue equals price, so you read price straight off the horizontal demand curve. Everywhere else marginal revenue lies below demand, so you find quantity at MR equals MC and then read the price UP on the demand curve.
Why marginal revenue falls below price when demand slopes down
A firm facing a downward-sloping demand curve has to cut the price to sell another unit, and unless it can price-discriminate it must cut the price on every unit it sells. So the revenue from one more unit is the new price MINUS the revenue lost on all the units that now sell for less. That is why marginal revenue is below price, and for a straight-line demand curve it falls twice as steeply. This is also why a monopoly never produces where demand is inelastic: in that region marginal revenue is negative, so cutting output would raise revenue and lower cost at the same time. See the diagram at /sandbox/monopoly.
The mistake that costs the most points
Reading the monopoly price off the point where MR equals MC is the single most common error in AP Microeconomics. That intersection gives you the QUANTITY. To get the price you go straight up from that quantity to the DEMAND curve and read across. The MR curve is a tool for finding quantity, not a price the firm charges. Price equals marginal revenue only in perfect competition, where the firm is a price taker and its demand curve is horizontal. Say the two steps out loud every time: quantity from MR equals MC, price up on demand. Practise on /sandbox/perfect-competition and /sandbox/monopoly back to back so the difference sticks.
Frequently asked questions
Why do firms produce where marginal revenue equals marginal cost?
Because that is the last unit worth making. While marginal revenue exceeds marginal cost, each additional unit adds more to revenue than to cost and so increases profit. Once marginal cost exceeds marginal revenue, each additional unit reduces profit. The quantity where they are equal maximises the gap between total revenue and total cost.
Why is marginal revenue below price for a monopoly?
Because a monopoly faces a downward-sloping demand curve and must lower the price to sell an extra unit. Unless it can price-discriminate, that lower price applies to every unit sold, so the revenue gained from the extra unit is offset by revenue lost on all the previous ones. For a straight-line demand curve, marginal revenue falls twice as steeply.
Do you read the price off MR equals MC?
No, and this is the most common error on the topic. MR equals MC gives the profit-maximising quantity. To find the price, go up from that quantity to the demand curve. Price equals marginal revenue only in perfect competition, where demand facing the firm is horizontal.
Live Production Costs graph. Drag the curves, or open the full version.
Live Monopoly graph. Drag the curves, or open the full version.
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