Chapter 7

Decision making 2profit maximisation

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CHAPTER CONTENTS
LEARNING OUTCOMES -------------------------------------------------- 81
COST, VOLUME, PROFIT ANALYSIS ------------------------------------ 82
INFLUENCES OF E-BUSINESS ON COST AND MARKET
BEHAVIOUR --------------------------------------------------------- 85

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LEARNING OUTCOMES
a) Demonstrate the point of profit maximization, graphically using total cost
and total revenue curves.
b) Calculate the point of profit maximization for a single product in the short
run using data.
c) Illustrate the potential impact on prices and competition of e-business and
globalisation.

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COST, VOLUME, PROFIT ANALYSIS

The following analysis is that of a firm s short-run breakeven point:
$

Total revenue
Total cost

Total profit

Quantity
BEP

Limitations:
Linear total revenue curve, disregards laws of demand which states as
quantity supplied increases, price must decrease.
Linear short run cost curve, assumes variable costs remain constant.
Fixed costs are assumed to be fixed.

Exercise 1
A college is considering purchasing a new photocopier for student use which will
cost $8,000. Variable costs per copy include $0.02 for paper, $0.01 for ink and
$0.03 for labour. Copies are sold at $0.1 per sheet.
Calculate the breakeven number of copies.

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The point of profit maximization

Total cost

MR

Total revenue

MC

Q1

QPM

Q2

Quantity

Key points:
Profit maximising point being the point where total revenue exceeds total
costs by the greatest amount.
Marginal revenue (MR) equals marginal cost (MC) at the profit maximising
point.

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Between Q1 and QPM

output.

MR > MC, thus profits will increase with increased

Between QPM and Q2

quantity produced.

MC > MR, thus profits will increase by reducing

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Exercise 2
Complete the following table and determine the profit maximizing level of
production.
Units

Average
Revenue
$ Per Unit

Total
Revenue
$

Total Cost
$

160

70

140

100

120

120

100

160

80

240

60

330

Profit $

Marginal
Revenue
$

Marginal
Cost $

Exercise 3
McIntyre Co, a profit maximising firm discovers that its marginal costs are greater
than its marginal revenues. What action should the firm take?
A

Stop production of the product altogether

Increase output and sales

Reduce output and sales

Reduce its fixed costs

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INFLUENCES OF E-BUSINESS ON COST AND MARKET

BEHAVIOUR
Advanced Communication Technologies (ACT) is the collective term for digital
technology.
The advent of ACT has had a dramatic impact upon various industries. The impact
has been twofold:
1

Reduced search costs for buyers.

Reduced supply costs for suppliers.

Reduced search costs

By reducing search costs for buyers, e-commerce increases the price elasticity of
demand for products as consumers are able to compare a wider range of prices
thus creating increased substitutes.

P0
P1
DACT

D0
Q0

Q1

Q2

Quantity

Following the reduction in price of a good from P0 to P1, in the absence of reduced
search costs, demand increases to Q1. However ACT increases the elasticity of the
demand curve, resulting in an overall increase in the quantity demanded at Q2.

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Reduced supply costs

For those products compatible with ACT such as music and print, ACT allows
additional units of a product to be sold, with little or no incremental variable costs.
The resulting impact of the above is to create a perfectly price elastic supply curve.
ACT Impact on Supply Curve
$

S0

P0

PACT

SACT

Q0

QACT

Quantity

With little or no increase in variable costs, supply becomes perfectly elastic. Thus
causing a price reduction from P0 to PACT, culminating in increased demand at
QACT.

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