[VanDieu]

Hi everyone, I don't understand why marginal cost (MC) has to be equal to marginal revenue (MR) to maximization. Do firms in reality produce with the quantity where MC=MR ? Could anyone who already done business tell me this, thank you.

[ebaines]

At the macro-economic level it's based on an assumption that if MC< MR, then a new competitor may enter the market with prices slightly lower than yours, thus driving down MR. In microeconomics it's based on the idea that lowering your price a bit will gain more business, and as long as MR>MC you can keep lowering price to increase revenue profitably. But it also assumes that either (a) you can keep your current business at current prices, and so lowering price gains marginal additional revenue, or (b) by lowering MR by x% you can increase volume by greater than x%.

In the real world this doesn't work except perhaps in a few isolated cases. Reason is two-fold. (1) In the real world the success of your business is often analyzed using metrics other than pure profit - such as margin percent. You will typically hear Wall Street analysts talking about a company's gross margins as a key metric - if margins are falling it may be because costs are rising or competition is driving down prices, so there is a bias that high margins are "good." The result is that there is a lot of pressure on firms to keep prices high even at the risk of lower overall profits. And (2): successful companies operate in markets that are not perfectly competitive - we have some customers who are less prone to shop purely on price than others, or we sell a product with unique features that some customers are willing to pay more for, or perhaps we can provide better customer service in certain local markets than other firms can. In these cases we can charge a higher price (and make more profit) than using MR=MC. So pricing is a complicated business - you don't just determine your marginal cost and set price from that, or you'd be leaving a lot of money on the table. On the other hand, so-called "bottom feeders" who have products with minimal features and offer minimal customer service but have low cost of manufacture are more likely to drive market prices towards their MC, with the idea of driving out the higher-priced competition.

[VanDieu]

Thank you, that is really helpul.