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7
Prot and Revenue Maximization

OVERVIEW
The purpose of this chapter is to develop a general framework for nding optimal solutions to managerial decision-making problems. This focuses on the decision-making process with respect to two organizational objectives: Prot maximization and total revenue maximization. This chapter considers prot maximization from two perspectives. At a more practical level, management will attempt to maximize prots by employing just the right amount of each factor of production subject to a predened budget constraint. At a much more general level, prot maximization may be viewed as an unconstrained or constrained optimization problem where the decision variable is the rms level of output. The marginal product of labor (MPL) is the change in total output given a unit change in the amount of labor used. The marginal revenue product of labor (MRPL) is the change in the rms total revenue resulting from a unit change in the amount of labor used. The marginal revenue product is the marginal product of labor times the selling price of the product, i.e., MRPL = P MPL. Total labor cost is the total cost of labor. The total cost of labor is the wage rate times the total amount of labor employed. The marginal resource cost of labor (MRCL) is the change in total labor cost resulting from a unit change in the number of units of labor used. If the wage rate (PL) is constant, then the wage rate is equal to the marginal cost of labor. A prot-maximizing rm that operates in perfectly-competitive output and input markets will employ additional units of labor up to the point
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where the marginal revenue product of labor is equal to the marginal labor cost, i.e., P MPL = PL. In general, for any variable input the optimal level of variable input usage is dened by the condition P MPi = Pi. The optimal combination of multiple inputs is dened at the point of tangency between the isoquant and isocost curves. The isoquant curve represents the different combinations of capital and labor that produces the same level of output. The slope of the isoquant is the marginal rate of technical substitution. The isocost curve represents the different combinations of capital and labor that the rm can purchase with a xed operating budget and xed factor prices. The slope of the isocost curve is the ratio of the input prices. The optimal combination of capital and labor usage is dened by the condition MPL/MPK = PL/PK. This condition may be rewritten as MPL/PL = MPK/PK, which says that a prot-maximizing rm will allocate its budget in such a way that the last dollar spent on labor yields the same amount of additional output as the last dollar spent on capital. This condition denes the rms expansion path. The objective of prot maximization may be dealt with more directly. The problem confronting the decision-maker is to choose an output level that will maximize prot. Dene prot as the difference between total revenue and total cost, both of which are functions of output, i.e., p(Q) = TR(Q) - TC(Q). The objective is to maximize this unconstrained objective function with respect to output. The rst-order and second-order conditions for a maximum are dp/dQ = 0 and d2p/dQ2 < 0, respectively. The protmaximizing condition is to produce at an output level at which MR = MC. Although prot maximization is the most commonly assumed organizational objective, rms that are not owner-operated, or rms that operate in an imperfectly competitive environment often adopt an organizational strategy of total revenue maximization. The rst-order and second-order conditions are dTR/dQ = 0 and d 2TR/dQ2 < 0, respectively. Assuming that rms are price takers in resource markets (the price of labor and capital are xed), because price and output are always positive, it can be easily demonstrated that the output level that maximizes total revenue will always be greater than the output level that maximizes total prot. This is because of the law of diminishing marginal product guarantees that the rate of increase in marginal cost is greater than the rate of increase in marginal revenue.

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Multiple Choice Questions

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MULTIPLE CHOICE QUESTIONS


7.1 Consider the production function Q = f(K, L), where K is capital and L is labor. The isocost equation: A. Summarizes the optimal employment of K and L when factor prices are varied. B. The same thing as an isoquant, except that K and L are measured in money terms. C. Summarizes all the possible combinations of K and L that rm can purchase with a given operating budget and variable factor prices. D. Summarizes all the possible combinations of K and L that rm can purchase with a given operating budget and xed factor prices. Suppose that the rms operating budget is $10,000 and that the price of labor (PL) and price of capital (PK) are $25 and $50, respectively. The rm should hire: A. 100 units of labor and 150 units of capital. B. 100 units of labor and 200 units of capital. C. 150 units of labor and 100 units of capital. D. 200 units of labor and 150 units of capital. Suppose that Q = f(K, L). If K is measured along the vertical axis and L is measured along the horizontal axis, then an increase in the rms operating budget will cause: A. A parallel shift of the isocost curve towards the origin. B. A parallel shift of the isocost curve away from the origin. C. The isocost curve to rotate in a counter clockwise direction. D. The isocost curve to rotate in a clockwise direction. Suppose that Q = f(K, L). If K is measured along the vertical axis and L is measured along the horizontal axis, then an increase in rental price of capital (PK) will cause: A. A parallel shift of the isocost curve towards the origin. B. A parallel shift of the isocost curve away from the origin. C. The isocost curve to rotate in a counter clockwise direction. D. The isocost curve to rotate in a clockwise direction. Suppose that Q = f(K, L). If K is measured along the vertical axis and L is measured along the horizontal axis, then an increase in rental price of labor (PL)will cause:

7.2

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A. B. C. D. 7.6

Prot and Revenue Maximization

A parallel shift of the isocost curve towards the origin. A parallel shift of the isocost curve away from the origin. The isocost curve to rotate in a counter clockwise direction. The isocost curve to rotate in a clockwise direction.

Suppose that Q = f(K, L) where K is measured along the vertical axis and L is measured along the horizontal axis. The slope of the isocost curve is: A. MPL/MPK. B. MPK/MPL. C. PL/PK. D. PK/PL. Suppose that Q = f(K, L) where K is measured along the vertical axis and L is measured along the horizontal axis. An increase in PK and PL will cause: A. A parallel shift of the isocost curve towards the origin. B. A parallel shift of the isocost curve away from the origin. C. The isocost curve to rotate in a counter clockwise direction. D. The isocost curve to rotate in a clockwise direction. Suppose that Q = f(K, L) where K is measured along the vertical axis and L is measured along the horizontal axis. The least-cost combination of K and L is achieved when: A. When the slope of the isocost line is greater than the slope of the isoquant. B. When the slope of the isoquant is greater than the slope of the isocost line. C. When the slope of the isocost line is equal to the slope of the isoquant. D. When the slope of the isocost line is tangent to the isoquant. E. Both C and D are correct. Suppose that Q = f(K, L) where K is measured along the vertical axis and L is measured along the horizontal axis. Suppose that at some input combination the slope of the isocost line is steeper than the slope of the isoquant. To increase output the rm should: A. Hire more K and less L. B. Hire more L and less K. C. Hire more of both K and L. D. Hire less of both K and L.

7.7

7.8

7.9

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7.10 Suppose that Q = f(K, L). A rm that is using K and L efciently when: A. P MPL = PL. B. P MPK = PK. C. MPL/MPL = PL/PK. D. Both A and B are correct. E. A, B, and C are correct. 7.11 Suppose that Q = f(K, L). If MPL/MPK > PL/PK, then: A. The rm should hire more capital. B. The rm should hire more labor. C. The rm should increase the price of labor. D. The rm should increase the price of capital. E. None of the above. 7.12 Suppose that a perfectly-competitive rm is producing efciently. If the rental price of labor (wage rate) is $6.25 and the marginal product of labor is 1.25 units, then the selling price of the product is: A. $1.50. B. $3.50. C. $5.50. D. $7.50. E. None of the above are correct. 7.13 Suppose that the selling price of a product is $12.50. If the rental price of price of capital is $50, then marginal product of capital is: A. 1 unit. B. 2 units. C. 3 units. D. 4 units. E. None of the above are correct. 7.14 Suppose that the rental price of capital is $22 units and the selling price of a product is $11.00. The marginal product of labor is: A. 1 unit. B. 2 units. C. 3 units. D. 4 units. E. Cannot be determine from the information provided.

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7.15 Suppose that the rms production function is Q = 2L0.5, where L represents units of labor. If the rm is operating efciently, then the selling price of the product is: A. $10. B. $50. C. $100. D. $200. 7.16 Suppose that the rms production function is Q = 20K0.5L0.5, where K is capital and L is labor. Suppose that K = 25, L = 100, and the rental price of capital is $80. If the rm is operating efciently, then the price of the product is: A. $1.25. B. $3.20. C. $4.00. D. $5.80. 7.17 Suppose that Q = f(K, L). If MPL = 12, MPK = 24, PL = $50 and PK = $100, then a prot maximizing rm should: A. Hire more labor. B. Hire more capital. C. Hire more labor and capital. D. Do nothing. 7.18 Suppose that Q = f(K, L), where K is capital and L is labor. The expansion path of a Cobb-Douglas production function is: A. Always linear. B. Always quadratic. C. Always cubic. D. Depends upon whether the production function exhibits increasing, decreasing or constant returns to scale. 7.19 Suppose that Q = f(K, L) where K is measured along the vertical axis and L is measured along the horizontal axis. The slope of the expansion path is: A. The capital-labor ratio. B. The labor-capital ratio. C. The output-capital ratio. D. The output-labor ratio. 7.20 Suppose that Q = 56K0.4L0.8 where K is measured along the vertical axis and L is measured along the horizontal axis. If the rental price of labor and capital are $80 and $40, respectively, then the rms expansion path is:

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A. B. C. D.

0.8(56)K0.4L-0.2 = 80. 0.4(56)K-0.6L0.8 = 40. K = L. K/L = 80/40.

7.21 Suppose that the rms prot equation is p = -172 + 288Q -8Q2. The prot-maximizing level of output for this rm is: A. 14 units. B. 18 units. C. 22 units. D. 26 units. 7.22 Suppose that the rms prot equation is p = -172 + 288Q -8Q2. The maximum prot for this rm is: A. $2,420. B. $3,860. C. $4,620. D. $5,222. 7.23 A prot-maximizing rm must always produce at an output level where: A. P = ATC. B. P = AVC. C. MR = ATR. D. P = MC. 7.24 Prot is maximized at the output level where the: A. Slope of the total revenue curve is greater than the slope of the total cost curve. B. Slope of the total revenue curve is the same as the slope of the total cost curve. C. Slope of the total revenue curve is less than the slope of the total cost curve. D. Slope of the marginal revenue curve is equal to slope of the marginal cost curve. 7.25 A perfectly-competitive rm maximizes prot at the output level where: A. Mp = 0. B. P = MC. C. MR = MC. D. Both A and C are correct. E. All of the above.

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7.26 The market-determined price of a product is $4. The total cost equation of a rm in a perfectly-competitive industry is TC = 100 + 20Q + Q2. The prot-maximizing rate of output is: A. 3 units. B. 4 units. C. 5 units. D. 6 units. 7.27 A monopolist maximizes prot at the output level where: A. Mp = 0. B. P = MC. C. MR = MC. D. Both A and C are correct. E. All of the above. 7.28 The market demand for the output of a monopolist is Q = 125 0.25P. The monopolists total cost equation is TC = 1,000 + 200Q + Q2. To maximize total prots the monopolist should charge a price of: A. $100. B. $250. C. $380. D. $540. 7.29 The market demand for the output of a monopolist is Q = 125 0.25P. The monopolists total cost equation is TC = 1,000 + 200Q + Q2. A revenue-maximizing monopolist would charge a price of: A. $166.67. B. $275.50. C. $350.00. D. $475.00. 7.30 Suppose that a rms total prot equation is p = -2,500 + 100x + 110y - 5xy - 0.5x2 - 0.5y2, where x and y represent the output levels from two production processes. The prot maximizing combination of x and y is: A. x = 10 and y = 8.67. B. x = 35.50 and y = 45. C. x = 50 and y = 43.33. D. x = 65.33 and y = 50.

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Shorter Problems

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SHORTER PROBLEMS

7.1

Suppose that a rm produces at an output level where MPL = 60 and PL = $30. Suppose, further, that MPK = 125 and PK = $50. A. Is this rm producing efciently? B. If the rm is not producing efciently, then how might it do so? Suppose that a rm produces at an output level where MPL = 36 and PL = $12. Suppose, further, that MPK = 48 and PK = $24. A. Is this rm producing efciently? B. If the rm is not producing efciently, then how might it do so? A rms production function is given by the equation: Q = 15K0.65L0.25 where input prices are PL = $5 and PK = $15. Determine the equation of the expansion path.

7.2

7.3

7.4

Suppose that a prot-maximizing rms production function is Q = 125(0.2K + 0.4L) where Q, K and L represent units of output, capital, and labor, respectively. A. Suppose that the price of capital per unit is PK = $25 and the price of labor per unit is PL = $12.50. What is the optimal input combination for this rm? B. Suppose that the price of capital remains PK = $25, but the price of labor rises to PL = $50. What is the rms optimal input combination? C. Suppose that the price of capital falls to PK = $5, while the price of labor remains unchanged at PL = $50. What is the rms optimal input combination?

7.5

Suppose that a rms estimated production function is: Q = 25L0.6K0.6 where Q represents units of output, K represents units of capital, and L represents units of labor. Suppose that the rental price of labor is PL = $100. If L = 15 and the price of the product is $5, estimate the optimal level of capital input.

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7.6 Q = 80K0.7L0.3

Prot and Revenue Maximization

The production function facing a rm is

The rm can sell all of its output for $10. The rental price of labor and capital are $7 and $12, respectively. A. Determine the optimal levels of capital and labor usage if the rms operating budget is $25,000. B. At the optimal levels of capital and labor usage, calculate the rms total prot. 7.7 The total revenue and total cost equations of a perfectly-competitive rm are: TR = 30Q TC = 55 - 25Q + 0.02Q2 A. What is the total prot function? B. Calculate the prot maximizing level of output? C. Calculate the rms prot at the prot-maximizing output level.

LONGER PROBLEMS
7.1 Suppose that the wage rate (PL) is $35, the rental price of capital (PK) is $75, and the rms operating budget is $17,500. A. What is the isocost equation for the rm? B. If capital is graphed on the vertical axis, what happens to the isocost line if the wage rate falls? C. If K is measured along the vertical axis and L is measured along the horizontal axis, what happens to the isocost line if the rental price of labor rises? D. If the wage rate and the rental price of capital remain unchanged, what happens to the isocost line if the rms operating budget decreases? E. If the rms operating budget remains unchanged, what happens to the isocost line if the wage rate and the rental price of capital decline by the same percentage? A rms production function is: Q = 65L0.5K0.5 where K is capital and L is labor. The prices of a unit of labor and capital and labor are $10 and $20, respectively. Suppose that the rms operating budget is $15,000. A. Estimate the optimal levels of labor and capital usage. B. Given your answer to part A., estimate the rms total output.

7.2

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7.3

The total cost equation for a perfectly-competitive rm is: TC = 20 + 2.5Q2 A. If the rm can sell all of its output for $20 per unit, calculate the rms prot-maximizing output level? At the prot-maximizing level of output, what is the rms total prot. B. Suppose that the market demand equation for this product is Q = 2,500 - 25P. If this rm was as monopoly, calculate the protmaximizing level of output. What price should the monopolist charge? At the prot-maximizing level of output, what is the monopolists total prot. C. What is the monopolists total-revenue maximizing level of output? At the total-revenue maximizing level of output, calculate the monopolists total prot.

7.4

The demand and total cost equations for the output of a monopolist are Q = 200 - 5P TC = Q3 - 8Q2 + 25Q + 10 A. What is the prot-maximizing level of output? B. What is the prot at this output level? C. Determine the prot-maximizing price per unit of output.

7.5

The demand and total cost equations for the output of a monopolist are Q = 80 - 2P TC = Q3 - 10Q2 + 58Q + 2 A. What is the prot-maximizing level of output? B. What is the prot at this output level? C. Determine the prot-maximizing price per unit of output.

7.6

A rms total prot equation is: p(x, y) = -900 + 360x - x2 - xy - y2 + 250y where x and y represent the output levels for the two product lines. A. Determine the prot-maximizing output levels of goods x and y subject to the side condition that the sum of the two product lines equal 500 units using the Lagrange multiplier method. B. Calculate the rms total prots. C. What is the interpretation of the Lagrange multiplier?

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D. Suppose that there were no combined output requirement. What are the prot maximizing levels of x and y? E. Given your answer to part D., what is the rms total prots?

ANSWERS TO MULTIPLE CHOICE QUESTIONS


7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 7.12 7.13 7.14 7.15 7.16 7.17 7.18 7.19 7.20 7.21 7.22 7.23 7.24 7.25 7.26 7.27 7.28 7.29 7.30 D. A. B. C. D. C. A. E. A. E. B. E. D. E. B. C. D. A. A. C. B. A. D. B. E. B. C. C. D. C.

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SOLUTIONS TO SHORTER PROBLEMS


7.1 A. The optimal input combination is given by the expression MPL/PL = MPK/PK 60/30 = 2 < 2.5 = 125/50 Thus, the rm is not operating efciently. B. To produce more efciently, the rm should reallocate its budget dollars away from labor and toward towards capital. A. The optimal input combination is given by the expression MPL/PL = MPK/PK 36/12 = 3 > 2 = 48/24 Thus, the rm is not operating efciently. B. To produce more efciently, the rm should reallocate its budget dollars away from capital and toward labor. The expansion path is determined from the expression MPL/PL = MPK/PK MPL/PL = (Q/L)/PL = [0.25(15)K0.65L-0.75]/PL MPK/PK = (Q/K)/PK = [0.65(15)K-0.35L0.25]/PK [0.25(15)K0.65L-0.75]/5 = [0.65(15)K-0.35L0.25]/15 K = (13/15)L A. MPL = Q/L = 50 MPK = Q/K = 25 MPL/PL = 50/12.50 = 4 MPK/PK = 25/25 = 1 Since MPL/PL > MPK/PK and the marginal products are constant, then the rm should use only labor. B. MPL/PL = 50/50 = 1 MPK/PK = 25/25 = 1 Since MPL/PL = MPK/PK and the marginal products are constant, then any combination of labor and capital that satisfy the rms budget constraint is efcient. C. MPL/PL = 50/50 = 1 MPK/PK = 25/5 = 5 Since MPK/PK > MPL/PL and the marginal products are constant, then the rm should use only capital.

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Prot and Revenue Maximization

Optimality requires that PL = P MPL. 100 = 5[(0.6)25L-0.4K0.6] = 5[15(15)-0.4K0.6] = 25.3878K0.6 K0.6 = 3.9389 K = 9.824 units of capital.

7.6

A. MPL/PL = MPK/PK [0.3(80)K0.7L-0.7]/7 = [0.7(80)K-0.3L0.3]/12 0.3K/7 = 0.7L/12 K = (4.9/3.6)L TC0 = PLL + PKK 25,000 = 7L + 12L 25,000 = 7L + 12(4.9/3.6)L L* = 1,071.43 25,000 = 7(1,071.43) + 12K K* = 1,458.33 B. p = TR - TC = PQ - TC = 10(80K0.7L0.3) - 25,000 10[80(1,458.33)0.7(1,071.43)0.3] - 25,000 = $1,038,599.67 7.7 A. p = TR - TC = 30Q - (55 - 25Q + 0.02Q2) = -55 + 55Q - 0.02Q2 B. dp/dQ = 55 - 0.04Q = 0, i.e., the rst-order condition for p maximization. d2p/dQ2 = -0.04 < 0, i.e., the second-order condition for p maximization is satised. Solving the rst-order condition for Q we obtain Q* = 1,375 C. p* = -55 + 55(1,375) - 0.02(1,375)2 = $37,757.50

SOLUTIONS TO LONGER PROBLEMS


7.1 A. TC0 = PLL + PKK 17,500 = 35L + 75K B. K = TC0/PK - (PL/PK)L If the wage rate falls, the isocost line will rotate counterclockwise, i.e., the K-intercept will remain unchanged while the L-intercept moves to the left. C. If the rental price of labor rises, then the isocost line will rotate clockwise, i.e., the K-intercept will remain unchanged while the L-intercept moves to the left.

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D. If the operating budget decreases, the isocost line will undergo a parallel shift toward the origin, i.e., the K-intercept will move down and the L-intercept will move to the left. The factor prices are unchanged, the slope of the isocost line will remain unchanged. E. If the wage rate and the rental price of capital decline by the same percentage, then the isocost line undergo a parallel shift away from the origin, i.e., the K-intercept will move up and the L-intercept will move to the right in the same proportion. The slope of the isocost line will remain unchanged. 7.2 A. The optimal combination of K and L is determined by the relation MPL/MPK = PL/PK MPL = Q/L = 0.5(65)L-0.5K0.5 MPK = Q/K = 0.5(65)L0.5K-0.5 [0.5(65)L-0.5K0.5]/[0.5(65)L0.5K-0.5] = 10/20 Solving for the optimal capital-labor ratio we obtain K/L = 1/2 K = 0.5L The rms isocost equation is TC0 = PLL + PKK 15,000 = 10L + 20K Substituting we obtain 15,000 = 10L + 20(0.5L) = 20L The optimal level of labor usage is L* = 750 The optimal level of capital usage is 15,000 = 10(750) + 20K K* = 375 B. Q* = 65(750)0.5(375)0.5 = 34,471.46 A. TR = P Q = 20Q p = TR - TC = 20Q - (20 + 2.5Q2) = -20 + 20Q - 2.5Q2 dp/dQ = 20 - 5Q = 0, i.e., the rst-order condition for p maximization. Solving the rst-order condition for Q we obtain Q* = 4 units d2p/dQ2 = -5 < 0, i.e., the second-order condition for p maximization is veried. p* = -20 + 20(4) - 2.5(4)2 = $20

7.3

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B. P = 100 - 0.04Q TR = P Q = 100Q - 0.04Q2 p = TR - TC = (100Q - 0.04Q2) - (20 + 2.5Q2) = -20 + 100Q - 2.54Q2 dp/dQ = 100 - 5.08Q = 0, i.e., the rst-order condition for p maximization. Solving the rst-order condition for Q we obtain Q* = 19.69 units d2p/dQ2 = -5.08 < 0, i.e., the second-order condition for p maximization is veried. P* = 100 - 0.04(19.69) = $99.21 p* = -20 + 100(19.69) - 2.54(19.69)2 = $964.25 C. dTR/dQ = 100 - 0.08Q = 0, i.e., the rst-order condition for TR maximization. Solving the rst-order condition for Q we obtain Q* = 1,250 d2TR/dQ2 = -0.08 < 0, i.e., the second-order condition for TR maximization is veried. p* = -20 + 100(1,250) - 2.54(1,250)2 = -$3,843,770 7.4 A. p = TR - TC P = 40 - 0.2Q TR = 40Q - 0.2Q2 p = TR - TC = (40Q - 0.2Q2) - (Q3 - 8Q2 + 25Q + 10) = -Q3 + 7.8Q2 + 15Q - 10 dp/dQ = -3Q2 + 15.6Q + 15 = 0 Q1,2 = [-b (b2 - 4ac)]/2a = {-15.6 [(15.6)2 - 4(-3)(15)]}]/2(-3) = [-15.6 (243.36 + 180)]/-6 Q1,2 = (-15.6 20.58)/-6 Q1 = -36.18/-6 = 6.03 Q2 = 4.98/-6 = -0.83 The second-order condition for prot maximization is d2p/dQ2 < 0. Taking the second derivative of the prot function yields d2p/dQ2 = -6Q + 15.6 Substituting the solution values into this condition we get d2p/dQ2 = -6(6.03) + 15.6 = -20.58 < 0, for a local maximum d2p/dQ2 = -6(-0.83) + 15.6 = 20.58 > 0, for a local minimum Thus, total prot is maximized at Q = 6.08 units. B. p* = -(6.03)3 + 7.8(6.03)2 + 15(6.03) - 10 = $144.81 C. P* = 40 - 0.2(6.03) = $38.79

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7.5

A. p = TR - TC P = 40 - 0.5Q TR = 40Q - 0.5Q2 p = TR - TC = (40Q - 0.5Q2) - (Q3 - 10Q2 + 58Q + 2) = -Q3 + 9.5Q2 - 18Q - 2 dp/dQ = -3Q2 + 19Q - 18 = 0 Q1,2 = [-b (b2 - 4ac)]/2a = {-19 [(19)2 - 4(-3)(-18)]}/2(-3) = (-19 145)/-6 Q1,2 = (-19 12.04)/-6 Q1 = -31.04/-6 = 5.17 Q2 = -6.96/-6 = 1.16 The second-order condition for prot maximization is d2p/dQ2 < 0. Taking the second derivative of the prot function yields d2p/dQ2 = -6Q + 19 Substituting the solution values into this condition we get d2p/dQ2 = -6(5.17) + 19 = -12.02 < 0, for a local maximum d2p/dQ2 = -6(-1.16) + 19 = 25.96 > 0, for a local minimum Thus, total prot is maximized at Q = 5.17 units. B. p* = -(5.17)3 + 9.5(5.17)2 - 18(5.17) -2 = $20.68 C. P* = 40 - 0.5(5.17) = $37.42 A. The formal statement of this problem is: Maximize: p(x, y) = -900 + 360x - x2 - xy - y2 + 250y Subject to: x + y = 500 (x, y) = -900 + 360x - x2 - xy - y2 + 250y + l(500 - x - y) The rst-order conditions are: /x = 360 - 2x - y - l = 0 /y = -x - 2y + 250 - l = 0 /l = 500 - x - y = 0 This is a system of three linear equations in three unknowns. Assuming that the second-order conditions for prot maximization are satised, we can solve this system of equations simultaneously to yield the optimal solution values. x* = 305 y* = 195 l* = -$445 B. p* = -900 + 360(305) - (305)2 - (305)(195) - (195)2 + 250(195) = -900 + 109,800 - 93,025 - 59,475 - 38,025 + 48,750 = -$32,875

7.6

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C. l* = /k = p*/k = -$445 The Lagrange multiplier says that, in the limit, a reduction in the rms combined output by 1 unit will result in a $445 increase in the rms maximum prot. Alternatively, an increase in the rms combined output by 1 unit will result in a $445 decrease in the rms maximum prot. D. The rst-order conditions are: p/x = 360 - 2x - y = 0 p/y = -x - 2y + 250 = 0 This is a system of two linear equations in two unknowns. Assuming that the second-order conditions for prot maximization are satised, we can solve this system of equations simultaneously to yield the optimal solution values. x* = 156.67 y* = 46.67 E. p* = -900 + 360(156.67) - (156.67)2 - (156.67)(46.67) - (46.67)2 + 250(46.67) = -900 + 56,401.20 - 24,545.49 - 7,311.79 - 2,178.09 + 11,667.50 = $33,133.33

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