Please see attached file
Fundamentals of Economics
A. Profit Maximization
Profit Maximization is the determination of the best output in relation to price levels so that returns for the firm are maximized. A company usually has profit goals that must be reach, so various strategies such as reducing production costs, adjusting sale prices, and maximizing output levels are used.
A company should always use profit maximization methods, but these methods may negatively affect consumers if the method results in poor-quality product or higher prices.
Two main methods are use in profit maximization: a) Total
Cost
-Total
Revenue
Method and b) Marginal Cost-Marginal Revenue Method.
a) Total revenue to total cost
Total revenue less total cost is the profit, expressed as Π =
TR
–
TC
. Total revenue is the total amount of money the company receives from selling its products, or from other aspects of its business operations. Total cost is the sum of all aspects of the company’s production and operations, including non-monetary costs. Non-monetary costs include items that were not paid in cash but were incurred, like the time spent by the owner managing the business, or the equivalent cost of using the land or machineries of the owners, as if they are being rented.
If non-monetary costs will not be included in the computation of revenue, an accounting profit will result, but it will not be the actual economic profit. To obtain the economic profit, all explicit and implicit costs should be accounted for, including opportunity costs.
To find out how much profit the firm actually make, costs have to be determined. All the information can be derived from ATC. As ATC = TC/Q, so TC = ATC x Q. Profit maximization levels can be found by the simple multiplication and subtraction approach. Profit maximization = Total Revenue (TR) – Costs (C). (NEWLY ADDED)
Criterion Score:
2
.
0
0
Comments on this criterion (optional): The submission explains Total Revenue and Total Cost.
However, the point at which profit maximization is reached and how it is recognized using total
revenue and total cost as criteria could not be located in the submission. Please revise and
resubmit.
b) Marginal revenue to marginal cost
Marginal revenue is the added revenue when one more unit of output is sold. The profit maximizing level of output for monopolists is arrived at after equating its marginal revenue and its marginal cost. This is also the same condition for profit maximization that a perfectly competitive firm uses in determining its output equilibrium level. Marginal revenue equals marginal cost is the condition firms in different market structures use in determining their profit maximizing level of output.
Marginal cost is the cost of the additional unit, or the cost of produce one more unit. It is hard to determine the exact cost of the last unit, but the average cost of a group of units can easily be calculated. The change in costs from a previous level is divided by the change in quantity from that level.
B. Calculation for Marginal Revenue
The change in total revenue through the increase of quantity by one unit is Marginal revenue. If total revenue is represented by Δ (price x quantity), then MR = ΔTR/ Δq, where q is quantity and the change in q is usually one.
Although the price is the amount the firm gets for selling one more unit, the price is not generally equal to marginal revenue. If the firm faces a downward-sloping curve, the firm has to lower its price in order to sell more units. The increase in quantity means all the previous units of the product gets a lower price.
For example, if the firm’s product is selling at $
20
and you sell
1
0 units, the revenue is $200. To sell one more unit, the firm has to lower the price to $1
9
. The gain is $19 from the additional unit. However, the firm also loses $1 each on the first
10
units that would have sold for $20 each. The Marginal Revenue from the
11
th unit therefore is only $9, not $19. Since $19 x 11 units = $209, the additional total revenue for producing 11 units is only $9.
Criterion Score:2.00
Comments on this criterion (optional): The submission provides an example of the marginal
revenue calculation. However, the rubric is looking for a discussion of the marginal revenue
increases and decreases in the given scenario. Additionally, the submission incorrectly states
“However, the firm also loses $1 each on the first 10 units that would have sold for $20 each. The
Marginal Revenue from the 11th unit therefore is only $9, not $19″. Please revise and resubmit.
Generally, there are two effects when a firm lowers its price: 1) consumers buy more units and 2) consumers pay less per unit. The Marginal return can be positive or negative, meaning one of the effects can have a larger impact than the other.
In the given scenario, the formula for marginal revenue MR = ΔTR/ Δq is used. Because the quantity increases by increments of one and Total Revenue also increase, Marginal Revenue decreases. The decreasing marginal revenue curve is because Company A is operating in a monopolistically competitive market structure. A monopolist will get revenue equal to the price from selling an additional unit, since the output of a monopoly affects the market price, unlike the output of competitive firms. Competitive firms have a constant Marginal Revenue curve.
C. Calculation for marginal cost
Criterion Score:1.00
Comments on this criterion (optional): A discussion on the increases and decreases of marginal
cost in the given scenario could not be located in the submission. Please revise and resubmit.
Total cost is the combination of fixed cost and variable cost: TC = VC + FC
Average total cost is total cost divide by the quantity of output: ATC + TC/Q
Marginal Cost = Change in Total Cost / Change in Quantity
The marginal cost is factored into the average total cost at every unit. Marginal cost generally starts at below average total cost in graphs because of fixed cost. When there is increase in quantity, the average total cost will decrease and the marginal cost will increase. Eventually, the two will intersect, with marginal cost continuing in its increase, pulling average total cost up. The marginal cost of the firm also serves as it supply curve.
D. Profit Maximization for Company Q
To determine the level of output at which profit is maximized, the data on market demand and prices have to be supplemented with data on Company A’s costs of production for different output levels. The table below shows the market demand schedule. The market demands more output as the price falls in column
7
. The total revenue is the total amount Company A receives from the corresponding levels of output. The marginal revenue in the third column is the change in total revenue per an additional unit in output.
Criterion Score:1.00
Comments on this criterion (optional): The submission provides a chart showing total revenue,
marginal revenue, ATC, total cost, and marginal cost. However, the point at which profit is
maximized also requires identification. Additionally, reviewing the calculations for marginal
revenue and marginal cost may prove to be helpful. Please revise and resubmit.
|
Qty. |
TR |
Marginal Revenue |
TC |
Average TC ATC=TC/Q |
Marginal Cost |
Price |
Profits |
|||||||
| 0 |
$0.00 |
$10.00 |
||||||||||||
| 1 |
$ 1 5 0 .00 |
1
50 |
$ 3 0 .00 |
30 .00 |
30 |
12 0 |
||||||||
| 2 |
$2 90 .00 |
1 4 5 |
$50.00 |
25.00 |
20 |
2 40 |
||||||||
| 3 |
$ 420 .00 |
140 |
$ 8 0.00 |
2 6 .67 |
340 |
|||||||||
| 4 |
$ 540 .00 |
13 5 |
$ 120 .00 |
40 | 420 | |||||||||
| 5 |
$650.00 |
130 |
$1 70 .00 |
34.00 |
50 |
4 80 |
||||||||
| 6 |
$750.00 |
125 |
$230.00 |
38.33 |
60 |
520 |
||||||||
| 7 |
$840.00 |
$300.00 |
42.86 |
70 | 540 | |||||||||
| 8 |
$920.00 |
115 |
$380.00 |
47.50 |
80 | |||||||||
| 9 |
$990.00 |
110 |
$470.00 |
52.22 |
90 | |||||||||
| 10 |
$1,050.00 |
105 |
$570.00 |
57.00 |
100 |
|||||||||
| 11 |
$1,100.00 |
$680.00 |
61.81 |
|||||||||||
| 12 |
$1,140.00 |
95 |
$800.00 |
66.66 |
||||||||||
| 13 |
$1,170.00 |
$930.00 |
71.54 |
|||||||||||
| 14 |
$1,190.00 |
85 |
$1,070.00 |
76.43 |
||||||||||
| 15 |
$1,200.00 |
$1,220.00 |
81.33 |
-20 |
The profit-maximization of a monopolistic firm is
MR = MC
like a competitive firm. The profit maximization level for Company A is 8 units at $115 per unit. The monopoly will make a profit of $540 at eight units of production.
Profit is maximized for Company A at the point where an added output will not change profit as in:
π = R –C
Δπ =
ΔR −
ΔC = 0
Δq
Δq
Δq
MR− MC = 0
MR = MC
Adjusting Output when Marginal Revenue is greater than Marginal Cost
When the company is producing too little, the Marginal Revenue is greater than marginal cost, and can increase its profits by increasing its output. By producing an additional unit after the 10th unit, the Company A can gain more revenue than it loses in cost, so it makes a marginal profit.
Adjusting Output when Marginal Cost is greater than Marginal Revenue
When the Marginal Cost of Company A is greater than Marginal Revenue then it is producing too much. Its profits can increase if it decreases its output.
References
BYU: Idaho. (n.d.). Market structure characteristics [Word Document]. Econ 150: Economic Principles
and Problems–
Micro. Retrieved from Lecture Notes Online Web site:
http://courses.byui.edu/ECON_150/ECON_150_Old_Site/Lesson_07.htm
ECON 600. Lecture 3: Profit Maximization. [PDF Document]. Retrieved from Lecture Notes Online:
http://www.csun.edu/~dgw61315/ECON600lect3
Marginal Cost (MC) & Average Total Cost (ATC). (n.d.). Economics.FundamentalFinance.com
Retrieved from
http://economics.fundamentalfinance.com/micro_atc_mc.php
