Question

Define a. marginal revenue b. law of diminishing marginal returns

Short answer

Marginal Revenue is the revenue gained from selling an additional unit of output. The Law of Diminishing Marginal Returns states that after a certain point, each additional unit of input will produce less additional output.

Step-by-step solution

Define Marginal Revenue

Marginal Revenue (MR) is an increase in total revenue that results from selling an additional unit of output. Mathematically, it is the derivative of the total revenue with respect to quantity (\(MR = \frac{d(TR)}{dQ}\)).

Define Law of Diminishing Marginal Returns

The Law of Diminishing Marginal Returns states that as additional units of a variable input are added to fixed inputs, after a certain point, the marginal product of the variable input declines. This means that each additional input will yield less and less additional output.

Key concepts

Law of Diminishing Marginal Returns

One of the fundamental principles in economics is the Law of Diminishing Marginal Returns. It explains a phenomenon that occurs within production when one input variable is incrementally increased. Imagine a local bakery that employs workers to bake bread. Initially, adding an extra worker can significantly increase the number of bread loaves produced. However, if the size of the bakery and the number of ovens remain the same—a fixed input—each additional worker will contribute less to the overall output than the previous one. Why does this happen?

It's simply because the fixed inputs limit the capacity for more production. When the bakery reaches full capacity, additional workers might even get in the way, reducing efficiency. This principle is crucial for businesses to understand when scaling their operations; more isn't always better if the supporting framework isn't scalable.

When studying or applying the Law of Diminishing Marginal Returns, keep these aspects in mind:

Marginal Product

When delving into the Law of Diminishing Marginal Returns, we encounter the term 'marginal product'. Marginal product refers to the extra output, or product, that is created as a result of adding one more unit of a variable input, such as labor. It is related to marginal revenue because it influences how much additional revenue can be generated from increasing the input.

Let's take our bakery example. The marginal product could be the number of additional loaves of bread produced by hiring one more baker. Initially, as you add more workers, the marginal product rises because of increased efficiency. However, due to the law of diminishing marginal returns, there comes a point where adding more workers will result in a decreasing marginal product. That's the moment where each new worker adds fewer bread loaves than the baker before them.

Understanding marginal product is vital for businesses as it helps to determine the optimal level of labor and resources needed for production. It is a key concept for making decisions about resource allocation, pricing, and production scaling.

Total Revenue

In the world of business and economics, total revenue is a term that represents the total amount of money a company receives from selling goods or services before any expenses are subtracted. It's a simple calculation: multiply the price at which goods or services are sold by the number of units sold. For example, if a company sells 100 units of a product at \(10 each, the total revenue would be \)1,000.

In the context of marginal revenue and the law of diminishing marginal returns, understanding total revenue is key. It is the broader context that marginal revenue fits into. Marginal revenue may decrease as production expands beyond a certain point because each additional unit adds less to the total revenue than the previous unit did, often due to market saturation or production inefficiencies.

Total revenue is a starting point for analyzing a company's performance, but one must also consider costs to truly understand profitability. Regardless, total revenue plays a critical role in strategic decisions, such as setting production levels and pricing strategies.