Profit maximization from the total revenue to total cost approach is at the point of the largest difference between total revenue and total cost. Profit maximization from the marginal revenue to marginal cost approach is where marginal revenue equals marginal cost. The calculation used to determine marginal revenue is the change in total revenue divided by the change in quantity. In this scenario, marginal revenue decreases by $10 at every additional increment of widget production.
The calculation used to determine marginal cost is the change in total cost divided by the change in quantity produced. Marginal cost increases by $10 at every increment produced in this given scenario. Profit maximization from the total revenue to total cost approach would have Company A producing no more than seven widgets. According to the total revenue to total cost approach, revenue is maximized where the difference between total revenue and total cost is the largest.
At seven widgets, the difference is at its apex of $540. At eight widgets the difference remains the same $540 but costs more than seven widgets to produce and is thus redundant. At nine widgets the difference is at $520 and the difference continues to decline for each subsequent widget produced. In the marginal revenue to marginal cost approach (where profit maximization occurs when marginal revenue equals that of marginal cost), profit maximization would have Company A’s production stop at eight widgets.
It’s at this point where marginal cost and marginal revenue are both $80. If it is determined that marginal revenue is greater than marginal cost, output should be adjusted to produce additional widgets until marginal revenue equals marginal cost. If it is determined that marginal cost is greater than marginal revenue, widget output should be decreased until marginal cost equals marginal revenue.