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7Output, Price, and Profit:
The Importance of Marginal Analysis
Business is a good game . . .You keep score with money.
NOLAN BUSHNELL, FOUNDER OF ATARI
![Page 2: 7 7 Output, Price, and Profit: The Importance of Marginal Analysis Business is a good game...You keep score with money. NOLAN BUSHNELL, FOUNDER OF ATARI](https://reader035.vdocuments.mx/reader035/viewer/2022062516/56649de95503460f94ae49e9/html5/thumbnails/2.jpg)
● Price and Quantity: One Decision, Not Two
● Total Profit: Keep your Eye on the Goal
● Marginal Analysis and Maximization of Total Profit
● Generalization: The Logic of Marginal Analysis and Maximization
● Price and Quantity: One Decision, Not Two
● Total Profit: Keep your Eye on the Goal
● Marginal Analysis and Maximization of Total Profit
● Generalization: The Logic of Marginal Analysis and Maximization
ContentsContents
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● Conclusion: The Fundamental Role of Marginal Analysis
● The Theory and Reality: A Word of Caution
● Appendix: The Relationships Among Total, Average, and Marginal Data
● Conclusion: The Fundamental Role of Marginal Analysis
● The Theory and Reality: A Word of Caution
● Appendix: The Relationships Among Total, Average, and Marginal Data
Contents (continued)Contents (continued)
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Price and Quantity: One Decision, Not TwoPrice and Quantity: One Decision, Not Two
● Firms face a demand curve on which price and quantity are related.
● They can choose either price or quantity, but not both.
● Firms face a demand curve on which price and quantity are related.
● They can choose either price or quantity, but not both.
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FIGURE 7-1 Demand Curve for Al’s Garages
FIGURE 7-1 Demand Curve for Al’s Garages
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
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D
Profit maximum
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Total Profit: Keep Your Eye on the GoalTotal Profit: Keep Your Eye on the Goal
● Simplifying assumption: maximum total profit is the firm’s goal.
● Total profit = total revenue - total costs
● Economic profit accounting profit
● Simplifying assumption: maximum total profit is the firm’s goal.
● Total profit = total revenue - total costs
● Economic profit accounting profit
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Total Profit: Keep Your Eye on the GoalTotal Profit: Keep Your Eye on the Goal
● Total, Average, and Marginal Revenue♦ Total Revenue = P Q
♦ Average Revenue = TR/Q = (P Q)/Q = P
♦ Marginal Revenue = total revenue from one more unit of output.
● Total, Average, and Marginal Revenue♦ Total Revenue = P Q
♦ Average Revenue = TR/Q = (P Q)/Q = P
♦ Marginal Revenue = total revenue from one more unit of output.
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TABLE 7-1 Demand for Al’s Garages
TABLE 7-1 Demand for Al’s Garages
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FIGURE 7-2 Total Revenue Curve for Al’s Garages
FIGURE 7-2 Total Revenue Curve for Al’s Garages
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
TR
A
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D E
F G H I
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Output, Garages Sold per Year
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Total Profit: Keep Your Eye on the GoalTotal Profit: Keep Your Eye on the Goal
● Total, Average, and Marginal Cost♦ The shapes of the cost curves mean that there
is some size for the firm that is most efficient.
♦ Firms that are smaller or larger than this optimal size will have higher average costs.
● Total, Average, and Marginal Cost♦ The shapes of the cost curves mean that there
is some size for the firm that is most efficient.
♦ Firms that are smaller or larger than this optimal size will have higher average costs.
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TABLE 7-2 Al’s Total, Average, and Marginal Costs
TABLE 7-2 Al’s Total, Average, and Marginal Costs
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FIGURE 7-3 (a) Cost Curves for Al’s Garages
FIGURE 7-3 (a) Cost Curves for Al’s Garages
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
TC
(a) Total Cost Output, Garages per Year
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FIGURE 7-3 (b) Cost Curves for Al’s Garages
FIGURE 7-3 (b) Cost Curves for Al’s Garages
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
(b) Average Cost Output, Garages per Year
5
Ave
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FIGURE 7-3 (c) Cost Curves for Al’s Garages
FIGURE 7-3 (c) Cost Curves for Al’s Garages
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
MC
(c) Marginal Cost Output, Garages per Year
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gin
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)
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Total Profit: Keep Your Eye on the GoalTotal Profit: Keep Your Eye on the Goal
● Maximization of Total Profits♦ Profits typically increase with output, then fall.
♦ Some intermediate level of output, therefore, generates the maximum profit.
● Maximization of Total Profits♦ Profits typically increase with output, then fall.
♦ Some intermediate level of output, therefore, generates the maximum profit.
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TABLE 7-3 TR, Costs, and Profit for Al’s Garages
TABLE 7-3 TR, Costs, and Profit for Al’s Garages
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Marginal Analysis and Maximization of Total ProfitMarginal Analysis and Maximization of Total Profit
● Marginal profit is the slope of the total profit curve.
● Profit is at a maximum when the marginal profit is zero.
● Marginal profit is the slope of the total profit curve.
● Profit is at a maximum when the marginal profit is zero.
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FIGURE 7-4 (a) Profit Maximization
FIGURE 7-4 (a) Profit Maximization
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
TC
TR
22,000
Profit
(a) Total Revenue. Total Cost Output, Garages per Year
5 To
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To
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FIGURE 7-4 (b) Profit Maximization
FIGURE 7-4 (b) Profit Maximization
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
5
(b) Total Profit Output, Garages per Year
Total profit
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D
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Marginal Analysis and Maximization of Total ProfitMarginal Analysis and Maximization of Total Profit
● Optimum Marginal Revenue and Marginal Cost♦ If MR > MC, production profits
♦ If MR < MC, production profits
● Profit maximizing level out output: MR = MC
● Optimum Marginal Revenue and Marginal Cost♦ If MR > MC, production profits
♦ If MR < MC, production profits
● Profit maximizing level out output: MR = MC
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TABLE 7-4 Al’s Marginal Revenue and Marginal Cost
TABLE 7-4 Al’s Marginal Revenue and Marginal Cost
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FIGURE 7-5(a) Profit Maxim: Another Graphical Interpretation
FIGURE 7-5(a) Profit Maxim: Another Graphical Interpretation
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
Output, Garages per Year (a) Marginal Revenue and Marginal Cost
5
MR
an
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MC
E
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FIGURE 7-5(b) Profit Maxim: Another Graphical Interpretation
FIGURE 7-5(b) Profit Maxim: Another Graphical Interpretation
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
TC
TR
22,000
Profit
(a) Total Revenue. Total Cost Output, Garages per Year
5 To
tal R
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ue,
To
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Yea
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s $)
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74 B
96 A
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FIGURE 7-5(c) Profit Maxim: Another Graphical Interpretation
FIGURE 7-5(c) Profit Maxim: Another Graphical Interpretation
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
5
(b) Total Profit Output, Garages per Year
Total profit
F
D
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10 9 8 7 6 4 3 2 1
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Marginal Analysis and Maximization of Total ProfitMarginal Analysis and Maximization of Total Profit
● Finding the Optimal Price from Optimal Output♦ MR = MC: rule for determining the level of
output
♦ Demand curve price buyers will pay to purchase that level of output
♦ Both output and price are now determined for the profit maximizing firm.
● Finding the Optimal Price from Optimal Output♦ MR = MC: rule for determining the level of
output
♦ Demand curve price buyers will pay to purchase that level of output
♦ Both output and price are now determined for the profit maximizing firm.
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Logic of Marginal Analysis & MaximizationLogic of Marginal Analysis & Maximization
● If a decision is to be made about the quantity of some variable, then maximize net benefit.
● Net benefit = total benefit - total cost
● To maximize net benefit, select a value of the variable at which marginal benefit = marginal cost.
● If a decision is to be made about the quantity of some variable, then maximize net benefit.
● Net benefit = total benefit - total cost
● To maximize net benefit, select a value of the variable at which marginal benefit = marginal cost.
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Logic of Marginal Analysis & MaximizationLogic of Marginal Analysis & Maximization
● Application: Fixed Cost and Profit Maximization♦ An increase in fixed costs does not change
optimal output or price because it does not affect marginal costs.
● Application: Fixed Cost and Profit Maximization♦ An increase in fixed costs does not change
optimal output or price because it does not affect marginal costs.
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TABLE 7-5 Rise in Fixed Cost: Total Profits Before and After
TABLE 7-5 Rise in Fixed Cost: Total Profits Before and After
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FIGURE 7-6 Fixed Cost Does Not Affect Profit-Maximizing Output
FIGURE 7-6 Fixed Cost Does Not Affect Profit-Maximizing Output
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5 10 9 8 7 6 4 3 2 1
Profit with a fixed cost
Profit with zero fixed cost
N
To
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Output in Garages per Year
M
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The Fundamental Role of Marginal AnalysisThe Fundamental Role of Marginal Analysis
● Marginal analysis can be used to illuminate many everyday problems, in business and elsewhere, sometimes with surprising results.
● For example, a new activity will add to profits if it more than covers its marginal cost, not the fully allocated average cost.
● Marginal analysis can be used to illuminate many everyday problems, in business and elsewhere, sometimes with surprising results.
● For example, a new activity will add to profits if it more than covers its marginal cost, not the fully allocated average cost.
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The Fundamental Role of Marginal AnalysisThe Fundamental Role of Marginal Analysis
● Any problem involving optimization can be illuminated with marginal analysis.
● The logic of marginal analysis can be applied to government, universities, hospitals and other organizations as well as businesses.
● Any problem involving optimization can be illuminated with marginal analysis.
● The logic of marginal analysis can be applied to government, universities, hospitals and other organizations as well as businesses.
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Theory and Reality: A Word of CautionTheory and Reality: A Word of Caution
● Business people seldom use marginal analysis in a literal sense.
● They often rely on intuition and hunches.
● But these theories can be used to understand and predict behavior.
● Business people seldom use marginal analysis in a literal sense.
● They often rely on intuition and hunches.
● But these theories can be used to understand and predict behavior.
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Appendix: Relationships Among Total, Average, and
Marginal Data
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● Average = total the number of units
● Total = average the number of units
● Average = total the number of units
● Total = average the number of units
Relationships Among Total, Average, and Marginal DataRelationships Among Total, Average, and Marginal Data
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Relationships Among Total, Average, and Marginal DataRelationships Among Total, Average, and Marginal Data
● Marginal value of the xth unit = total value of x units - total value of (x - 1) units.
● Total value of x units = marginal values of the first x units.
● Marginal value of the xth unit = total value of x units - total value of (x - 1) units.
● Total value of x units = marginal values of the first x units.
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TABLE 7-6 Weights of Persons in a Room (in pounds)
TABLE 7-6 Weights of Persons in a Room (in pounds)
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● The marginal, average and total values for the first unit are usually equal.♦ If marginal < average, the average is falling.
♦ If marginal > average, the average is rising.
♦ If marginal = average, the average is constant; that is, the average is at a maximum or minimum.
● The marginal, average and total values for the first unit are usually equal.♦ If marginal < average, the average is falling.
♦ If marginal > average, the average is rising.
♦ If marginal = average, the average is constant; that is, the average is at a maximum or minimum.
Relationships Among Total, Average and Marginal DataRelationships Among Total, Average and Marginal Data
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FIGURE 7-7 Relationship between Marginal and Average Curves
FIGURE 7-7 Relationship between Marginal and Average Curves
Copyright © 2003 South-Western/Thomson Learning. All rights reserved.
F
E
A D
B
C
Average weight
Marginal weight
Mar
gin
al a
nd
Ave
rag
e W
eig
ht
(po
un
ds)
Number of Persons
6 5 4 3 2 1 0
50
100
150