Microeconomics: Price Level Determination Using MR and MC Analysis

This assignment delves into the critical relationship between marginal revenue (MR) and marginal cost (MC) in determining price levels within microeconomics. It explains how firms utilize these measures to decide on pricing and output levels to maximize profits. The assignment differentiates between imperfect and perfect competition, illustrating how the intersection of MR and MC curves determines price in a monopoly market, where the demand curve slopes downward. Conversely, in a perfectly competitive market, the price equals average and marginal revenue, and firms adjust output until MR equals MC. The analysis includes graphical representations and references, emphasizing that the structure of MR and MC is crucial for setting price levels and achieving profit maximization. The assignment highlights the importance of understanding these economic concepts for effective business decision-making.

Microeconomics

Marginal revenue and marginal cost are critical to deciding price level. Explain-The
measures of marginal cost of production, as well as the marginal revenue, are used to determine
the level of price that the firm will charge as well as the amount of the output that the firm will
be willing to supply for any given level of prices. This is a general statement that the sole aim of
an organization is to achieve the maximum level of profits. The relationship that exists between
the marginal revenue, as well as the marginal cost, are the important determinant that helps to
find the point of profit maximization through the pricing mechanism. In other words, the point at
which marginal revenue equals marginal cost is the point where the company maximizes its
profit through charging a particular price level satisfying the equilibrium conditions. When we
talk about the marginal cost of production, it measures the additional change in the total cost
for a commodity that has been incurred from the production of an incremental unit of output. The
calculation of marginal cost involves dividing the additional change in the total cost of
production by one additional unit of output is produced (Posner, R. A., 1975). In the method of
calculus, the calculation of marginal cost involves finding the first order derivative of any given
function of total cost in respect of the quantity. Suppose that we are given that
the total cost of production for ten units of the pen is $50 and further total cost of producing 11
units of the pen is $55. Now, the marginal cost of production for the 11th unit would be the
change in the total cost of production that has taken place as a result of the additional production
of one unit i.e. $5. When we talk about the marginal revenue, it is
defined as the additions made to the revenue (whether positive or negative) that occurs when
there is sale of additional unit of quantity that has been produced. Through the calculus method,
the marginal revenue is defined as to be calculated in the form of first order derivative of the
total revenue function with an additional unit of the quantity being produced .
If suppose that the price of a pen is given to be $5 and in a company, there are 20 pens produced
in each day then the total revenue is calculated by the product of the price with the total number
of units produced i.e. 5*20 = $100. Now suppose Similarly if 21 units of a pen are sold then the
total revenue will be $105. So, in this case, marginal revenue from selling 21st additional unit is
$5.
In the case of imperfect competition, the aim of every firm as we discussed above is to earn an
optimum level of profits. This implies that they want to maximize the difference between their
returns i.e. the total revenue as well as the total cost. As long as, the marginal revenue earned
from the sale of a commodity is larger than the marginal cost associated with selling it, it will be
profitable for the firm to pursue its sales (Baumol, W. J., & Blinder, A. S., 2015). However, just
after the point where the marginal cost starts to exceed the marginal revenue, there will be losses
to the firm, and it will stop selling and producing. Now the important point to note here is that
this relationship between marginal revenue as well as the marginal cost here will be crucial
to the determination of the price level. This is shown as in figure 1. In figure 1, the marginal
revenue curve, as well as the demand curve, are different from each other as well as downward
sloping because under imperfect completion more output can only be sold by lowering the price

level. In the diagram, the point where the MR curve, as well as MC curve, intersect,
corresponding to it, the point where the vertical line from Q intersect the demand curve will be
the point of determination of price level i.e. P.
Figure 1 Diagram representing price determination in the monopoly market
In figure 1, the marginal revenue curve, as well as the demand curve, are different from each
other as well as downward sloping because under imperfect completion more output can only be
sold by lowering the price level. In the diagram, the point where the MR curve, as well as MC
curve, intersect, corresponding to it, the point where the vertical line from Q intersect the
demand curve will be the point of determination of price level i.e. P. However in the situation
of perfectly competitive firm, the situation is slightly different. Although if we talk about the
marginal cost, then it is similar for both competitive as well as non-competitive markets. But in
the perfectly competitive firms when we speak of the price then it is equal to the average revenue
as well as marginal revenue curve. In fact, all the three of them coincide within one horizontal
line parallel to an axis representing quantity levels (figure 2). This shows that for all the
quantities produced or sold the price level has been kept at a constant and equal to the marginal
revenue.However, the marginal cost levels can be higher or lower than the marginal revenue and
the price level. If the marginal cost is lower than the marginal revenue and the price level i.e. left
of Q (figure 2) then since the firms are getting more price than the costs incurred, so they will
keep on selling the product. This process of selling the quantity will continue up to the point
where eventually MR=P=MC (Q in figure 2). After this point, if the firm tries to produce further
then, the additional cost associated with the quantity sold or produced will be higher than the
marginal revenue earned or the price charged by the firm. This will incur more losses to the firm,
and it will eventually reduce the level of product to Q only.
Figure 2 diagram representing price determination in perfectly competitive market

Hence, we can say that the structure of marginal revenue, as well as marginal cost levels, are
crucial for the determination of the price levels (Nas, T. F., 2016).
REFERENCES
Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and Policy. Cengage
Learning.
Nas, T. F. (1996). Cost-Benefit Analysis: Theory and Application. SAGE.
Nas, T. F. (2016). Cost-benefit analysis: Theory and application. Lexington Books.
Posner, R. A. (1975). The social costs of monopoly and regulation. Journal of Political
Economy, 83(4), 807-827.
Schoengold, K., & Zilberman, D. (2014). The economics of tiered pricing and cost functions:
Are equity, cost recovery, and economic efficiency compatible goals?. Water Resources and
Economics, 7, 1-18.