synopsis

The Synopsis

Profit maximization by cost control Soudha Amanullah

MBA 2014-2015

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Profit maximization by cost control

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Synopsis

Name : Soudha Amanullah

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Project Topic : Profit maximization by cost control

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Synopsis Content

Contents Introduction ............................................................................................................................................ 4

Research design ...................................................................................................................................... 5

Profile of the company ............................................................................................................................ 5

Purpose of research................................................................................................................................. 5

Objective ................................................................................................................................................. 6

Key questions .......................................................................................................................................... 6

Analysis & Interpretations ....................................................................................................................... 7

Research methodology ............................................................................................................................ 9

Research findings .................................................................................................................................... 9

Conclusions ............................................................................................................................................. 9

Suggestions ............................................................................................................................................. 9


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Introduction A monopoly is a firm that is the exclusive seller of a product with which there are no close

substitutes. The monopoly retains this control because it is not possible for other firms to enter

into that particular market; therefore, eliminating competition over the selling of that product.

This concept is known as barriers to entry.

The fundamental difference between a competitive firm and a monopolistic firm is the

monopolys influence over the price of its product or output. This arises because a competit ive

firm is too small in relation to its market in which it operates to have any control over the price

of its output. However, a monopoly does not face this dilemma because it is the only producer

in its market so it adjusts the price of its output by simply changing the quantity it supplies. This

illustrates the characteristic of a monopolistic firm as a price maker. Since monopolies are the

only producer in its market and are price makers they face a downward sloping market demand

curve and thus must sell at a lower price in order to sell more output.

Like a competitive firm, a monopoly operates at maximum profit where its marginal revenue

equals its marginal cost. However, its marginal revenue curve is no longer equal to its demand

curve because the downward sloping quality of its demand curve causes the monopoly to lower

its prices in order to increase the quantity, resulting in less revenue per extra unit of output.

Therefore, in order to find the price a monopoly charges you must determine the profit-

maximizing quantity where its marginal revenue equals its marginal cost and then go up to its

demand curve at that quantity.


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Research design Explicit costs require an outlay of money,

e.g. paying wages to workers

Implicit costs do not require a cash outlay, example) the opportunity cost of the

owners time

Opportunity Costs The cost of something is what you give up to get it.

This is true whether the costs are implicit or explicit. Both matter for firms decisions

Profile of the company

Purpose of research What price needs to set?

What Quantity to Produce?

Profits and the Average Cost Curve

Entry, Exit, and Shutdown Decisions

Entry, Exit, and Industry Supply Curves


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Objective Method of cost reduction in prefect competition and Monopolistic market conditions

Key questions 1. Why is a monopolys demand curve downward sloping and what affect does this have

on its profit-maximization price and quantity?

2. What should a monopoly do if its price equals its average total cost?

a. Increase output

b. Lower its price

c. Nothing, it is making zero profits

d. Decrease output

e. Raise its price

f. It is not a monopoly

3. What should a monopoly do if its price equals its marginal cost?

a. Increase output

b. Lower its price

c. It is making zero profits

d. Decrease output

e. Raise its price

f. It is not a monopoly

4. What is characteristic of a monopolys marginal revenue curve?

a. It is the same as its demand curve

b. It decreases as quantity sold increases

c. It is a horizontal line

d. It increases as quantity sold decreases


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Analysis & Interpretations Example #1:

Imagine there is some sort of monopoly over a product of software, like Microsoft. In columns 1

and 2 of Table 11.a.1 we can see the demand schedule for this particular monopoly. From this

you can see that as the quantity increases the price decreases, representing the downward

sloping demand curve characteristic of monopolies. The third column computes the firms total

revenue which calculates the quantity sold (column 1) times the price (column 2). By looking

solely at this column we would conclude this firm should produce at a quantity of 3 or 4.

However, we can take it one step further by computing the firms profit by subtracting the

firms total cost (column 4) from its total revenue (column 3) at each quantity. This column

indicates that at 4 units the firm will experience a loss in profit even though it appeared the

firm was earning its highest revenue at 4 units.

As a result, you must use the firms marginal cost and marginal revenue to accurately calculate

its profit maximization. Marginal cost can be computed by calculating the increase in the total

cost (column 4) from an additional unit of output (column 1) produced. Similarly, marginal

revenue can be computed by calculating the change in total revenue (column 3) from an

additional unit of output (column 1) sold. Once those values have been computed you can

compare the firms marginal cost and marginal revenue values to determine the actual profit

maximization. From the table it is evident that the firms marginal cost is less than its marginal

revenue up until the second unit is sold. However, if the firm were to produce the third unit it

would cost the firm $4 while that third unit only brought in $2 of additional revenue. Therefore,

from the table we can conclude that this monopolistic firms profit-maximizing quantity is about

2 units and its profit-maximizing price is about $5.

Once, you have a firm understanding of how the numbers in Table 11.a.1 are computed the

next step is to transfer the numbers onto a graph in Figure 11.a.1. In this figure it is evident that

this firms profitmaximizing quantity is about 2, while its profit-maximizing price is about $5

which is what consumers will be willing to pay for 2 units. In order to calculate the profit

received by this firm we need to calculate the firms average total cost at every quantity by


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dividing the firms total cost by quantity. This is illustrated in the column 6 of Table 11.a.1.

Since we already know the profit-maximizing quantity is about 2 we just look at the average

total cost value at the quantity of 2 in the table which is $4. Now that we have all of these

values we just need to plug it into the total profit equation (P ATC) x Q which equals a

total profit of $2 ((5-4) x 2). This total profit of $2 is illustrated by the purple rectangle in Figure

11.a.1.

*Black numbers indicate given values, while red numbers indicate calculated values.

Table 11.a.1

Quantity Price Total

Revenue

(P x Q)

Total

Cost

Profit

(TR - TC)

Average Total

Cost

(TC / Q)

Marginal

Cost

Marginal

Revenue

0 $7 $0 $3 $-3 $

1 6 6 5 1 5

2 5 10 8 2 4

3 4 12 12 0 4

4 3 12 17 -5 4.25

5 2 10 23 -13 4.6

6 1 6 30 -24 5

> $2

> 3

> 4

> 5

> 6

> 7

> $6

> 4

> 2

> 0

> -2

> -4


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Research methodology

Research findings

Conclusions

Suggestions

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