Final answer:
Firms utilize activity-based costing to get a detailed understanding of operational costs and guide their production decisions. They experiment with production levels to see the effects on profits, focusing on the balance between marginal revenue and marginal cost to maximize profits.
Step-by-step explanation:
Firms can improve planning, product costing, and control by using activity-based costing to develop detailed descriptions of the specific actions performed in the firm's operations. Activity-based costing is a method that assigns costs to products and services based on the resources they consume. This approach helps firms understand their costs better and make more informed decisions about pricing, budgeting, and management.
Since firms often lack the data needed to create a complete total cost curve for all levels of production, they engage in experimentation. By adjusting production levels slightly up or down, firms can observe the impact on profits. This practice is rooted in the economic principle of balancing marginal revenue and marginal cost.
In this context, marginal revenue refers to the additional income from selling one more unit of a good or service, whereas marginal cost is the cost of producing that additional unit. Understanding the relationship between the two can guide firms toward decisions that maximize profits. When marginal revenue exceeds marginal cost, it is generally profitable to increase production. Conversely, if marginal cost is higher than marginal revenue, reducing production might be more advantageous.