MR=MC… or not.

By May 26, 2016 November 13th, 2016 No Comments

Marginal revenue equals marginal cost is a mainstay of neoclassical economics. I learned it in school and I’ve taught it to kids. While you work through the math it’s very plausible, but the Austrians object. They say that businesses maximize their revenue without regard to their costs and thus aim for the midpoint of their demand curve, not for the price that makes MR=MC. This reflects my actual experiences managing businesses.

We never targeted marginal cost. In fact, we hardly knew what our “marginal economic cost” was. Gross margin is as close as we come to measuring something like that. I kept track of my actual incremental cost to be sure I didn’t go below that, but I would sometimes sell below gross margin to maximize revenue and profit.

Also, I tried to keep the cost figures to myself; I didn’t want the sales people to know our costs bc they would tend to think they had more “room” to go down in a negotiation. I told them, “get the highest price the market will bear. Don’t worry about what our costs are; that has nothing to do with you. You’re job is to know the market and find the highest prices.” That is, I explicitly sought to keep the sales side (price) and the production side (cost) separate.

So I’m now very skeptical of MR=MC. Econ students blurt it out the way geometry students say “pi-r-squared”. It’s keystone doctrine.

But interestingly, the article below from a mainstream source does mention that “some economists (Austrians are like Voldemort: he-who-can’t-be-named) reject the core assumptions of neoclassical economics as unrealistic… …based on achieving economic utopia, not explaining how real markets operate.” This is actually a fair portrayal of the position of the school-who-must-not-be-named in a mainstream piece. Refreshing! They also credit Menger as part of the marginal revolution.

If you haven’t taken Jeff Herbener’s video class, “what’s wrong with textbook economics”, www.supportinglisteners.com/whats-wrong-with-textbook-economics/ you really should. He goes thru Samuelson’s book chapter by chapter with surgical precision and demolishes fundamental things like MR=MC. Point by point, he says, “this claim is not realistic… here’s what really happens…” And I’m going, “Yeah! That’s what I’ve seen happen! That’s what I’ve actually done!”