Question

Marginal analysis is a key tool in helping businesses and individuals allocate scarce resources to maximize production. Marginal analysis measures the costs and benefits of the next unit of a good or service. Consider this example from personal life: You usually go on vacation for seven days and are considering going for an eighth day. To decide, you measure the benefits of the additional day against its costs. Benefits would include increased relaxation and the chance to do new activities or see new sights. Costs would include additional expenses and additional time away from work and/or friends.

In business, marginal analysis is used to compare the additional benefit of producing one more unit or service to the costs of that same action. Companies have limited resources available—money, labor, time—so they seek to determine how best to use those resources. For example, a video game producer will measure the costs of producing one more game against the projected revenue from the sale of that additional game. Using marginal analysis, the company would assess increasing production of the video game until marginal benefit (revenue) equals marginal costs (MB = MC).
The point where marginal benefits equal marginal costs is the point of maximum revenue or profit. After that production point, it costs the company more to produce additional units than it is worth. Supply and demand are the key factors that determine the point of maximum profit. If the company produces more video games than people buy, there is a surplus and revenue slows. If they produce too few, demand might be satisfied by competing products. Analyzing supply and demand curves allows a business to determine the optimal level of production.
Instructions
Read the following scenario. Then, write a paragraph explaining whether the company should increase or decrease production, providing reasons for your decision.
Company A makes computer servers. They produce 50 servers at a total cost of $50,000 and sell them for $1,200 each, for total revenue of $60,000. If the company produces a 51st server, its total revenue will be $61,200 and its total cost will be $51,500. Should the company produce that 51st server? Why or why not?

Answer 1

Company A should not produce the 51st server as the marginal cost of $1,500 exceeds the marginal revenue of $1,200, reducing total profit.

Step-by-step explanation:

Using marginal analysis, Company A should assess whether producing the 51st server adds to their total profit. The marginal cost of the 51st server is obtained by the increase in total cost, which is $51,500 minus $50,000, resulting in $1,500. The marginal revenue from selling the 51st server is $1,200. Since the marginal cost ($1,500) is higher than the marginal revenue ($1,200), producing the 51st server would not add to the company's profit but instead reduce it. In this case, the marginal cost exceeds the marginal benefit, suggesting that Company A should not increase production to the 51st server as it would lead to a decrease in overall profitability.

The company should produce the 51st server because the additional revenue gained from selling it ($1,200) exceeds the additional cost of producing it ($500). According to marginal analysis, a company should continue producing as long as the marginal revenue is greater than the marginal cost, as this will maximize profit. In this case, the marginal benefit (revenue) is $1,200 and the marginal cost is $500, resulting in a positive marginal profit of $700.