Managerial Economics Chapter 2

THE FIRM’S BASIC PROFIT MAXIMIZATION PROBLEM

Chapter 2 slide 1

What Quantity of Output should the Firm Produce and Sell and at What Price?
The Answer depends on Revenue and Cost Predictions. The Solution is Found using Marginal Analysis.

Expand an Activity if and only if the Extra Benefit exceeds the Extra Cost.

MAXIMIZING PROFIT FROM MICROCHIPS

2.2 A1. Focus on a single Product, A2. whose Revenues and Costs can be predicted with Certainty. Revenue can be predicted using the Demand Curve. P = 170 - 20Q or equivalently, Q = 8.5 - .05P

Write profit as  = R - C

Price ($ 000) 170

130
90

50
Quantity in Lots

0

2

4

6

8

THE FIRM’S OPTIMAL OUTPUT DECISION
R, C

The Firm determines Output where MR = MC.

2.3



C = 100 + 38Q

300 200 100 0 M = 0 R = 170Q - Q2



-100
0 2

3.3

4

6

8

Q

MAXIMIZING PROFIT ALGEBRAIC SOLUTIONS

2.4

Start with Demand and Cost Information
P = 170 - 20Q and C = 100 + 38Q

Therefore, R = 170Q - 20Q2 so MR = 170 - 40Q and MC = 38

Setting MR = MC implies 170- 40Q = 38 or 132 = 40Q Q* = 132/40 = 3.3 lots P* = 170 - (20)(3.3) = $104 K

* = 343.2 - 225.4 = 117.8

MAXIMIZING PROFIT USING MARGINAL GRAPHS Set MR = MC.
170

2.5

There is always a tradeoff.

P* Maximum Contribution
38

Demand MC MR Q*

SENSITIVITY ANALYSIS

2.6

Considers changes in: Fixed Costs, Marginal costs, or Demand Conditions
170

A change in fixed cost has no effect on Q* or P* (because MR and MC are not affected).

P* Demand
38

MC

Q*

SENSITIVITY ANALYSIS
Considers changes in: Marginal costs An increase in MC implies a fall in Q and an increase in P. Demand

2.7

170

38

MC’ MC

Q’ Q*

SENSITIVITY ANALYSIS

2.8 Finally, consider a change in Demand Conditions.

170

P P* Shift in Demand MC

38

Q*

Q