The approach we used to understand how a firm determines output is known as marginal analysis. This simple, but powerful, approach will not only let us determine
what the individual firm's supply curve looks like, but will be
at the heart of our analysis of firm behavior in most industrial
structures. Indeed, most of microeconomic theory is based on this
type of reasoning. Using this analysis, we know the following:
- Increase output if MR > MC
- Increase output if the marginal revenue (added revenue) exceeds the marginal cost
(additional cost) of producing another unit, since
this will increase profit.
- Reduce output if MR < MC
- Reduce output if the marginal revenue (added revenue) is less than the marginal cost (additional
cost) of producing another unit. In this case, reducing
output reduces costs more than it reduces revenue, increasing
profits.
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