Chapter 2 ECONOMIC OPTIMIZATION The purpose of managerial economics is to provide a systematic framework for problem analysis and solution.

The pluses and minuses of various decision alternatives must be carefully measured and weighed. Costs and benefits must be reliably measured; time differences must be accurately reflected. The collection and characterization of relevant information is the most important step of this process. After all relevant information has been gathered, managers must accurately state the goal or goals that they seek to achieve. Without a clear understanding of managerial ob ectives, effective decision making is impossible. !nce all relevant information has been gathered, and managerial ob ectives have been clearly stated, the managerial decision making process can proceed to the consideration of decision alternatives. "ffective managerial decision making is the process of efficiently arriving at the best possible solution to a given problem. #f only one solution is possible, then no decision problem e$ists. When alternative courses of action are available, the decision that produces a result most consistent with managerial ob ectives is the optimal decision. The process of arriving at the best managerial decision, or best problem resolution, is the focus of managerial economics. This chapter introduces fundamental principles of economic analysis, which are essential to all aspects of managerial economics and form the basis for describing demand, cost, and profit relations. !nce basic economic relations are understood, the tools and techni%ues of optimization can be applied to find the best course of action. CHAPTER OUTLINE MMMMMMMMMMMMMMMMMMMMDLX. PROCESS A. ECONOMIC OPTIMIZATION

Optimal Decisi !s" The best decision produces the result most consistent with managerial objectives. 1. Economic concepts and methodology are used to select the optimal course of action in light of available options and objectives.

B.

Ma#imi$i!% the &al'e ( the )irm" In managerial economics, the primary objective of management is ma imi!ation of the value of the firm. Influences that must be considered include" #1$%#. #1$%'. #1$%(. prices and the &uantity sold. cost relations. the appropriate discount rate.

MMMMMMMMMMMMMMMMMMMMDLXI.

RE&ENUE RELATIONS

)))))))))))))))))))))))))))))))))))))))))))))))))))))))) Price a!* T tal Re+e!'e" Total revenue is the amount sold in dollars. 1. #. *i+e all financial data, revenue figures are often studied using computer spreadsheets that show functional relations using formulas and e&uations. If price is constant regardless of the &uantity sold, the relation between &uantity sold and total revenue is simply T& ' ( ) *. a. b. ,enerally spea+ing, T& - f ./0. Total revenue .T&0, the variable to the left of the e&ual sign, is called the dependent variable. Its value depends on the si!e of the variable variables to the right of the e&ual sign. 1ariables on the right2hand side of the e&ual sign are called independent variables. Their values are determined independently of the functional relation e pressed by the e&uation.

c.

33333333333333333333333333333333333333333333333333333333 Mar%i!al Re+e!'e" 4arginal revenue is the change in total revenue caused by a one2unit change in the number of units sold . *0. In calculus terminology, +& ' ,T&-,*. ##$5$. ,enerally spea+ing, a marginal relation is the change in the dependent variable caused by a one2unit change in an independent variable. ##$5%. 6hen marginal revenue is positive, total revenue is increasing. If marginal revenue is negative, total revenue is decreasing. ##$57. 6hen a linear relation e ists between price and the number of units sold, both price and marginal revenue relations begin at the same point on the .2a is, but marginal revenue falls twice as fast as price with respect to output.

88888888888888888888888888888888888888888888888888888888888888888888 Re+e!'e Ma#imi$ati ! E#ample" 9evenue ma imi!ation occurs at the point of greatest total revenues. #':(:. 9evenue ma imi!ation involves consideration of revenue relations only. ;ost relations are not considered. #':(1. To find the revenue2ma imi!ing output level, set +& - :, and solve for *.

#':(#. To be consistent with long2run profit ma imi!ation, the advantages of short2run revenue ma imi!ation must be at least sufficient to compensate for the corresponding loss in short2run profitability. MMMMMMMMMMMMMMMMMMMMDLXII. A. COST RELATIONS

T tal C st" Total costs are comprised of fi ed costs and variable e penses that fluctuate with output. 1. Because all costs are variable in the long run, long2run fi ed costs always e&ual !ero. In the long run, the firm has complete fle ibility with respect to input use. The short run is the operating period during which the availability of at least one input is fi ed.

#. B.

Mar%i!al a!* A+era%e C st" 4arginal cost is the basis for short2run operating decisions< average cost is the basis for long2run planning decisions. 1. 4arginal cost is the change in cost associated with a 12unit change in output. In calculus terminology, +C ' ,TC-,*. 4arginal costs must be covered by added revenues to justify production in the short run. Average cost is total cost divided by output, or AC ' TC-*. In the long run, average costs must be covered by revenues or the company will go out of business. 6hen marginal cost is greater .less0 than average cost, average cost is increasing .decreasing0.

#.

'. ;.

A+era%e C st Mi!imi$ati ! E#ample" The average2cost minimi!ing activity level is the optimal production level for a target level of output. 1. #. Average cost is minimi!ed when +C ' AC. Average cost ma imi!ation involves consideration of cost relations only. 9evenue relations are not considered.

MMMMMMMMMMMMMMMMMMMMDLXIII. PRO)IT RELATIONS A. T tal a!* Mar%i!al Pr (it" Total profit is ma imi!ed when the optimal level of output is produced efficiently. 1. Total profit e&uals total revenue minus total cost. ,raphically, it is e&uivalent to the vertical distance between the total revenue and total cost curves at any output level.

#.

4arginal profit is the change in total profit associated with a 12unit change in output. In calculus terminology, +/ ' ,/-,*. .Economists use the 9oman letter =>? for price and the ,ree+ letter pi for profit.0.

B.

Pr (it Ma#imi$ati ! E#ample" The profit2ma imi!ing activity level is the optimal production level for an optimal level of output. #'@@#. Total profit is ma imi!ed when +/ ' +& 0 +C - :. E&uivalently, profits are ma imi!ed when +& ' +C. #'@@'. The slopes of the total revenue and total cost curves measure marginal revenues .+&0 and marginal costs .+C0. 6here these slopes are e&ual, +& - +C and profit is ma imi!ed. #'@@(. 6hereas revenue ma imi!ation involves consideration of revenue relations only and average cost ma imi!ation involves consideration of cost relations only, profit ma imi!ation involves consideration of both revenue and cost relations.

MMMMMMMMMMMMMMMMMMMMDLXI&. IN ECONOMIC ANAL,SIS

THE INCREMENTAL CONCEPT

AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA Mar%i!al &ers's I!creme!tal C !cept" Incremental analysis involves e amining the impact of alternative managerial decisions on revenues, costs, and profits. It focuses on changes or differences between available alternatives. #(#'#. The incremental change is the difference resulting from a given decision. #(#''. 4arginal relations measure only the effect associated with unitary changes in output.

,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,, I!creme!tal Pr (its" Incremental profit is the profit gain or loss associated with a given managerial decision. 1. #. 6hen incremental profit is negative, total profit declines. Incremental profit is positive .and total profit increases0 if the incremental revenue associated with a decision e ceeds incremental cost.

BBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBBB I!creme!tal C !cept E#ample" The incremental concept is important for managerial decision ma+ing because it focuses attention on the differences among available alternatives. 1. 9evenues and costs that are unaffected by a decision are irrelevant and should be e cluded from analysis.

MMMMMMMMMMMMMMMMMMMMDLX&.

SUMMAR,

PROBLEMS & SOLUTIONS P2.1 Marginal Analysis. Characterize each of the following statements as true or false, and e$plain your answer. A. B. C. #f marginal revenue is greater than average revenue, the demand curve is downward sloping. (rofit is minimized when total revenue e%uals total cost. 1iven a downward2sloping demand curve and positive marginal costs, profit2 ma$imizing firms always sell more output at lower prices than revenue2 ma$imizing firms. +arginal cost must be less than average cost for average cost to decline as output e$pands. +arginal profit is the difference between marginal revenue and marginal cost, and always e$ceeds zero at the profit2ma$imizing activity level.

D. E. P2.1

SOLUTION A. Aalse. Because average revenue is falling along a downward sloping demand curve, marginal revenue must be less than average revenue for the demand curve to slope downward. Aalse. >rofits are ma imi!ed when marginal revenue e&uals marginal cost. >rofits e&ual !ero at the brea+even point where total revenue e&uals total cost. >rofits are minimi!ed when the difference between total revenue and total cost is at a ma imum. Aalse. >rofit ma imi!ation involves setting marginal revenue e&ual to marginal cost. 9evenue ma imi!ation involves setting marginal revenue e&ual to !ero. ,iven a downward sloping demand curve and positive marginal costs, revenue ma imi!ing firms charge lower prices and offer greater &uantities of output than firms that ma imi!e profits. True. Average cost falls as output e pands so long as marginal cost is less than average cost. If this condition is met, average costs decline whether marginal costs are falling, rising or constant. Aalse. 4arginal profit e&uals marginal revenue minus marginal cost, and e&uals !ero at the profit ma imi!ing activity level.

-.

C.

D.

E. P2.2

Revenue Ma i!i"a#i$n% Ta&les. +arketing director (eter (etrelli has derived the following price-demand information from a market e$periment for a new closet2 space organizer product called +a$ 3eadroom4

Pri'e 5677 896 867 8;6 877 <96 <67 <;6 <77 ;96 ;67 ;;6 ;77 :96 :67 :;6 A. B. P2.2

Pr$(u'# De!an( 7 : ; < 8 6 = 9 > ? :7 :: :; :< :8 :6

@se a spreadsheet to calculate total and marginal revenue at each level of product demand. At what price level is total revenue ma$imizedA WhyA

SOLUTION A. Total and marginal revenue at each level of product demand are as follows" Pr *'ct Dema!* . : 1 # ' ( T tal Re+e!'e TR/P. 222 D(%@ 5:: 1,#%@ 1,$:: Mar%i!al Re+e!'e MR/TRC . 222 D(%@ (#@ '%@ '#@

Price P D@:: (%@ (@: (#@ (::

Price P '%@ '@: '#@ ':: #%@ #@: ##@ #:: 1%@ 1@: 1#@ -.

Pr *'ct Dema!* . @ $ % 7 5 1: 11 1# 1' 1( 1@

T tal Re+e!'e TR/P. 1,7%@ #,1:: #,#%@ #,(:: #,(%@ #,@:: #,(%@ #,(:: #,#%@ #,1:: 1,7%@

Mar%i!al Re+e!'e MR/TRC . #%@ ##@ 1%@ 1#@ %@ #@ .#@0 .%@0 .1#@0 .1%@0 .##@0

At a price level of D#@: and product demand of 1: units, total revenue is ma imi!ed at a level of D#,@::. >rior to that point, the added sales from a decrease in price more than compensate for the loss in revenue from charging current customers a lower price. At prices lower than D#@:, the loss in revenue from charging current customers a lesser price is greater than the gain in revenues from new customers, and total revenue declines. As seen in the marginal revenue column, total revenue increases so long as marginal revenue is positive, but declines when marginal revenue is negative.

P2.0

A+era%e C st Mi!imi$ati !" Ta1les. 4ende! 4achine Tools, *td., has been as+ed to submit a bid on the projected cost of sophisticated production machinery. To help in the bid development process, Isaac 4ende!, head of product &uality control, has prepared the following schedule of projected volume and production costs"

Ou#)u# 7 : ; < 8 6 = 9 > ? :7 :: :; :< :8 :6 A. B. P2.*

T$#al C$s# 567,777 6:,967 68,777 6=,967 =7,777 =<,967 =>,777 9<,;67 9?,677 >=,;67 ?<,677 :7;,;67 :::,677 :;;,;67 :<8,677 :67,777

@se a spreadsheet to calculate the marginal and average cost at each level of production. At what level of production is average cost minimizedA WhyA

SOLUTION A. 4arginal and average cost at each level of production appears as follows"

O'tp't : 1 # ' ( @ $ % 7 5 1: 11 1# 1' 1( 1@ -.

T tal C st D@:,::: @1,%@: @(,::: @$,%@: $:,::: $',%@: $7,::: %',#@: %5,@:: 7$,#@: 5',@:: 1:#,#@: 111,@:: 1##,#@: 1'(,@:: 1@:,:::

Mar%i!al C st 222 D1,%@: #,#@: #,%@: ',#@: ',%@: (,#@: @,#@: $,#@: $,%@: %,#@: 7,%@: 5,#@: 1:,%@: 1#,#@: 1@,@::

A+era%e C st 222 D@1,%@:.:: #%,:::.:: 17,51$.$% 1@,:::.:: 1#,%@:.:: 11,'''.'' 1:,($(.#5 5,5'%.@: 5,@7'.'' 5,'@:.:: 5,#5@.(@ 5,#51.$% 5,(:'.7@ 5,$:%.1( 1:,:::.::

4inimum average costs of D5,#51.$% are reali!ed at an activity level of 1# units of output. Eotice from the marginal cost column that average cost falls so long as marginal cost is less than average cost. Average cost rises so long as marginal cost is greater than average cost. Average cost reaches a minimum when marginal cost switches from being lower than average cost to being greater than average cost.

P2.2

Pr (it Ma#imi$ati !" Sprea*sheet A!al3sis. *incoln Burrows, a writing instrument design specialist at Ao 9iver Ftate >en, Inc., has been as+ed to project the profit2 ma imi!ing activity level for a given design during the coming period. 9elevant demand and cost information are as follows"

+ 7 : ; < 8 6 = 9 > ? :7 :: :; :< :8 :6 A.

P 5:,77 7 ?=7 ?;7 >>7 >87 >77 9=7 9;7 =>7 =87 =77 6=7 6;7 8>7 887 877

TC 5677 987 ?>7 :,;;7 :,8=7 :,977 :,?87 ;,:>7 ;,8;7 ;,==7 ;,?77 <,:87 <,<>7 <,=;7 <,>=7 8,:77

Construct a table Bor spreadsheetC showing total revenue, marginal revenue, marginal cost, average cost, total profit, marginal profit, and average profit for this product at the various activity levels indicated previously. #dentify the profit2ma$imizing activity level. #s the profit2ma$imizing activity level the same activity level as that at which minimum average costs are e$periencedA WhyA or Why notA

B. C. P2.,

SOLUTION
A. A table .or spreadsheet0 showing total revenue, marginal revenue, marginal cost, average cost, total profit, marginal profit, and average profit for this product at the various activity levels is as follows"

. : 1 # ' ( @ $ % 7 5 1: 11 1# 1' 1( 1@

P D1,::: 5$: 5#: 77: 7(: 7:: %$: %#: $7: $(: $:: @$: @#: (7: ((: (::

TR / P. D: 5$: 1,7(: #,$(: ','$: (,::: (,@$: @,:(: @,((: @,%$: $,::: $,1$: $,#(: $,#(: $,1$: $,:::

MR / TR4 . 222 D5$: 77: 7:: %#: $(: @$: (7: (:: '#: #(: 1$: 7: : .7:0 .1$:0

TC D@:: %(: 57: 1,##: 1,($: 1,%:: 1,5(: #,17: #,(#: #,$$: #,5:: ',1(: ','7: ',$#: ',7$: (,1::

MC / TC4 . 222 D#(: #(: #(: #(: #(: #(: #(: #(: #(: #(: #(: #(: #(: #(: #(:

AC / TC4. 222 D%(:.:: (5:.:: (:$.$% '$@.:: '(:.:: '#'.'' '11.(' ':#.@: #5@.@$ #5:.:: #7@.(@ #71.$% #%7.($ #%@.%1 #%'.''

5/ TR6TC .D@::0 ##: 7$: 1,(#: 1,5:: #,':: #,$#: #,7$: ',:#: ',1:: ',1:: ',:#: #,7$: #,$#: #,':: 1,5::

M5 / 54 . 222 D%#: $(: @$: (7: (:: '#: #(: 1$: 7: : .7:0 .1$:0 .#(:0 .'#:0 .(::0

A5 / 54. 222 D##:.:: (':.:: (%'.'' (%@.:: ($:.:: ('$.$% (:7.@% '%%.@: '((.(( '1:.:: #%(.@@ #'7.'' #:1.@( 1$(.#5 1#$.$%

-.

>roduction and sale of 1: units at a price of D$:: .or 5 units and a price of D$(:0 is the profit2ma imi!ing activity level. >rofits are ma imi!ed at a level of D',1::. >rior to this point, the marginal revenue associated with additional sales e ceeds their associated marginal cost, marginal profit is positive, and total profit rises with an e pansion in output. Fubse&uent to this point, the marginal revenue associated with additional sales is less than their associated marginal cost, marginal profit is negative, and total profit falls with an e pansion in output. Eo, the profit2ma imi!ing activity level is not the same activity level as that at which minimum average costs are e perienced. In this problem, marginal costs are a constant D#(: per unit. 6ith fi ed costs of D@::, average costs continue to fall as output e pands< they approach D#(: as a lower limit. Although average costs continue to diminish as output e pands, ever lower prices must be offered to generate these added sales. Total profits fall as output e pands beyond 1: units because marginal revenues are less than marginal costs beyond that point. It is important to recogni!e that profit ma imi!ation re&uires a comparison of marginal revenues and marginal costs< average cost minimi!ation involves a comparison of marginal cost and average cost relations only .revenue effects are not considered0.

C.

P2.-

Marginal Analysis% Ta&les. +ichael Dcofield, a student at +innesota Dtate @niversity, is preparing for final e$ams and has decided to devote five hours to the study of managerial economics and finance. DcofieldEs goal is to ma$imize the

average grade earned in the two courses, and must decide how much time to spend on each e$am. Dcofield realizes that ma$imizing the average grade in the two courses is e%uivalent to ma$imizing the sum of the grades. According to DcofieldFs best estimates, the grades achieved will vary according to the schedule shown below. Managerial E'$n$!i's /$urs $0 S#u(y 7 : ; < 8 6 A. 1ra(e ;6 86 =6 96 >< ?7 .inan'e /$urs $0 S#u(y 7 : ; < 8 6

1ra(e 67 =; 9; >: >> ?<

Gescribe the manner in which Dcofield could make use of the marginal concept in managerial economics to assist in determining the optimal allocation of five hours between the two courses. 3ow much time should Dcofield spend studying each sub ectA #n addition to managerial economics and finance, Dcofield is also taking a marketing course. Dcofield estimates that each hour spent studying marketing will result in an eight point increase on the marketing e$amination score. Dcofield has tentatively decided to spend three hours preparing for the marketing e$am. #s DcofieldFs attempt to ma$imize the average grade in all three courses with three hours devoted to marketing and five hours devoted to managerial economics and finance Ballocated as in part HC an optimal decisionA WhyA or Why notA

B. C.

P2.-

SOLUTION A. An optimal allocation of study time is one that will permit Fcofield to ma imi!e the average grade earned in the managerial economics and finance courses. This ma imi!ation will occur when Fcofield allocates each hour of study time to that course where the marginal grade value of study time is greatest. To determine how much time Fcofield should spend studying each subject a table illustrating the marginal grade value of each hour of study time must be constructed. This table reads as follows"

-.

Ma!a%erial Ec ! mics H 'rs ( St'*3 : 1 # ' ( @ 7ra*e #@ (@ $@ %@ 7' 5: Mar%i!al 7ra*e &al'e 22 #: #: 1: 7 % H 'rs ( St'*3 : 1 # ' ( @

)i!a!ce 7ra*e @: $# %# 71 77 5' Mar%i!al 7ra*e &al'e 22 1# 1: 5 % @

6ith only five hours to study, Fcofield should spend three hours on managerial economics and two hours on finance. C. Eo, FcofieldGs decision to spend three hours studying for the mar+eting e am is incorrect if the objective is to ma imi!e the average grade received in managerial economics, finance and mar+eting. Hnly two hours should be allocated to studying mar+eting because an additional hour spent on finance would increase the total grade achieved by nine points< one point more than the eight point gain associated with the third hour spent preparing for the mar+eting e am, and will lead to a ma imum average grade.

P2.8

Mar%i!al A!al3sis" Ta1les. 4onica ,eller is a regional media consultant for Ariendly Images, Inc., a Eew 3or+2based media consultant. ,eller has gathered the following data on wee+ly advertising media e penditures and gross sales for a major client, ,reenwich 1illage= s ;entral >er+ ;offeehouse.

1r$ss Sales .$ll$2ing Pr$!$#i$n in #3e .$ll$2ing Me(ia% A(ver#ising E )en(i#ure 57 :77 ;77 <77 877 677 A. Ne2s)a)er 5:7,777 :;,777 :<,>77 :6,877 :=,=77 :9,;77 Ra(i$ 5:7,777 :8,777 :9,=77 ;7,;77 ;;,777 ;;,877 Televisi$n 5:7,777 :<,777 :6,=77 :>,777 :>,=77 :>,>77

Construct a table Bor spreadsheetC showing marginal sales following promotion in each media. BAssume here and throughout the problem that there are no synergistic effects across different media.C #f the Central (erk Coffeehouse has an advertising budget of 5677 per week, how should it be spentA WhyA Calculate the profit ma$imizing advertising budget and media allocation assuming the Central (erk Coffeehouse en oys an average profit contribution before media e$penditures of =I on store2 wide sales. 3ow much are ma$imum weekly profits Bbefore ta$esCA

B. C.

P2.4

SOLUTION A. A table showing marginal sales generated by promotion in each media appears as follows"

Mar%i!al Sales ) ll 9i!% Pr m ti ! i! the ) ll 9i!% Me*ia" A*+ertisi!% E#pe!*it're D: 1:: #:: ':: (:: @:: -. Ne9spaper 222 D#,::: 1,7:: 1,$:: 1,#:: $:: Ra*i 222 D(,::: ',$:: #,$:: 1,7:: (:: Tele+isi ! 222 D',::: #,$:: #,(:: $:: #::

Ising the data in part A, and given a D@:: advertising budget, gross sales and profit contribution are ma imi!ed by allocating D':: to radio and D#:: to television advertising. Irrespective of whether the ;entral >er+ ;offeehouse see+s to ma imi!e revenues or profit, this e penditure allocation is optimal. ,iven an average profit contribution before media e penditures of $J on store2wide sales, an additional dollar of advertising will be profitable so long as it returns more than D1$.$% in additional revenues. That is, the profit contribution on additional revenues of D1$.$% is just sufficient to cover media costs of D1 .- D1$.$% :.:$0. The profit ma imi!ing advertising budget is D5:: per wee+ allocated as" D#:: on newspaper, D(:: on radio, and D':: on television. 4a imum wee+ly profits are" Base sales K Eewspaper sales K 9adio sales K Television sales ,ross margin ,ross profit 2 4edia costs Eet profit .before ta 0 D1:,::: ',7:: 1#,::: 7,::: D'',7:: :.:$ #,:#7 5:: D 1,1#7

C.

P2.5

Pr$0i# Ma i!i"a#i$n% E6ua#i$ns. 1regory 3ouses, #nc. operates with the following revenue and cost functions4 T& ' 5:77* 2 57.6*; BTotal &evenueC

+& ' T&-* ' 5:77 2 5:* TC ' 5:,677 2 5:7* J 57.6*; +C ' TC-* ' 2 5:7 J 5:*

B+arginal &evenueC BTotal CostC B+arginal CostC

where * represents the %uantity of output produced and sold as measured by thousands of hours of temporary accounting services B777C. A. B. P2.5 Det +/ ' +& 2 +C ' 7 to determine the profit2ma$imizing price-output combination for AT#. Dhow that marginal revenue e%uals marginal cost at this profit2ma$imizing output level.

SOLUTION A. Fet 4L - 49 2 4; - : to ma imi!e profits, where" 4L - 49 2 4; : - D1:: 2 D1/ K D1: 2 D1/ #/ - 11: / - @@ .:::0 And, > - T9C/ - .D1::/ 2 D:.@/#0C/ - D1:: 2 D:.@/ - D1:: 2 D:.:@.@@0 -. - D%#.@: At / - @@ .:::0, note that" 49 - D1:: 2 D1/ - D1:: 2 D@@ - D(@ 4; - 2D1: K D1/ - 2D1: K D@@ - D(@ This numerical finding illustrates the general result that if 4L - 49 2 4; - :, then 49 - 4; will always be true.

P2.7

Pr$0i# 8ersus Revenue Ma i!i"a#i$n. West Wing (roducts, #nc., based in Gurham, Kew 3ampshire, produces and sells a wide variety of replacement parts and e%uipment for light aircraft. Leo +c1arry, a product line specialist for the company, is reviewing the company= s #nternet marketing strategy for a popular flight manual. Gemand and cost relations for the guidebook are given by the e%uations4 ( ' 5:66 2 57.76* +& ' T&-* ' 5:66 2 57.:* TC ' 596,777 J 56* J 57.7:;6*; +C ' TC-* ' 56 J 57.7;6* where * is the %uantity produced and sold per week. A. B. C. Calculate the revenue2ma$imizing price-output combination. Calculate the profit2ma$imizing price-output combination. Are the differences in your answers to parts A and H typical or atypicalA "$plain. BGemandC B+arginal &evenueC BTotal CostC B+arginal CostC

P2.7

SOLUTION A. Fet 49 - : to find the revenue2ma imi!ing output level" 49 - D1@@ 2 D:.1/ : - D1@@ 2 D:.1/ :.1/ - 1@@ / - 1,@@: Because total revenue is declining beyond this point, / - 1,@@: is a point of ma imum revenues. And, > - D1@@ 2 D:.:@.1,@@:0 - D%%.@: -. Fet 4L - 49 2 4; - : to find the profit2ma imi!ing output level" 4L - 49 2 4;

: - D1@@ 2 D:.1/ 2 D@ 2 D:.:#@/ :.1#@/ - 1@: / - 1,#:: Because total profit is declining for / M 1,#::, / - 1,#:: is a point of ma imum profits. And, > - D1@@ 2 D:.:@.1,#::0 - D5@ C. This is a typical result< so long as the product demand curve slopes downward and marginal cost e ceeds !ero, revenue ma imi!ation results in greater output .here, 1,@@: versus 1,#::0 and lower prices .here, D%%.@: versus D5@0 than is true with profit ma imi!ation.

P2.9

Pr$0i# Ma i!i"a#i$n 8ersus Average C$s# Mini!i"a#i$n. #mmensely popular mystery writer Dtan +arsh has ust published a new book titled MDouth (ark, Colorado.@ &elevant monthly demand and cost relations for this hard cover title are4 ( ' 5<6 2 57.77796* +& ' T&-* ' 5<6 2 57.77:6* TC ' 567,777 J 56* J 57.7776*; +C ' TC-* ' 56 J 57.77:* BGemandC B+arginal &evenueC BTotal CostC B+arginal CostC

where * is the number of books produced and sold per month. A. B. C. P2.9 Calculate the profit2ma$imizing price-output combination and profit level. Calculate the average cost2minimizing price-output combination and profit level. Contrast your answers to parts A and H.

SOLUTION A. To find the profit2ma imi!ing activity level, set 4L - 49 2 4; - :" 4L - 49 2 4;

: :.::#@/ / >

- D'@ 2 D:.::1@/ 2 D@ 2 D:.::1/ - ': - 1#,:::. - D'@ 2 D:.:::%@.1#,:::0 - D#$.

- T92T; - D'@/ 2 D:.:::%@/# 2 D@:,::: 2 D@/ 2 D:.:::@/# - 2D@:,::: K D':/ 2 D:.::1#@/# - 2D@:,::: K D':.1#,:::0 2 D:.::1#@.1#,:::#0 - D1':,:::

Because total profit is declining for / M 1#,:::, / - 1#,::: is a point of ma imum profits per month. .Kote" A publisherGs price of D#$ is consistent with a boo+store price of roughly D'@.0 -. To find the average cost2minimi!ing activity level, set 4; - A;" 4; - A; - T;C/ D@ K D:.::1/ - .D@:,::: K D@/ K D:.:::@/#0C/ D@ K D:.::1/ - D@:,:::C/ K D@ K D:.:::@/ :.:::@/ - @:,:::C/ /# - 1::,:::,::: / - 1:,::: > - D'@ 2 D:.:::%@.1:,:::0 - D#%.@: L - 2D@:,::: K D':.1:,:::0 2 D:.::1#@.1:,::: #0 - D1#@,:::

Because average cost is rising for / M 1:,:::, / - 1:,::: is a point of minimum average costs per month. C. >rofit ma imi!ation involves a comparison of the marginal revenues and marginal costs of production. Average2cost minimi!ation involves a consideration of cost relations only. Therefore, it is not surprising that these two approaches often yield different priceCoutput combinations. In this instance, the added revenues associated with an additional #,::: units beyond the average cost2minimi!ing level of 1:,::: is so great as to overcome the disadvantage of somewhat higher average costs at the 1#,::: units versus 1:,::: units activity level.