Chapter Nine: Output, Price, and Profit: The Importance of Marginal Analysis

Price and Quantity: One Decision, Not Two Optimal Decisions: The firms decisions go as far as possible, given the circumstances, to promote the consumers and producers goals. Among all decisions, its the best for the decision maker Labor requirements, consumer response, future success Firm can pick a pair on a demand curve Assumption that businesses go for max profit Each point on the demand curve represents a price-quantity pair. The firm can pick any such pair. But it can never pick the price corresponding to one point on the demand curve and the quantity corresponding to another point, because such an output could not be sold at the selected price. Total Profit: Keep Your Eye on the Goal Total Profit: A firms net earnings during some period of time. It is equal to the total amount of money the firm gets from sales of its products (the firms total revenue) minus the total amount that it spends to make and market those products (total cost) TP = TR - TC Economic profit takes opportunity cost into account Total, Average, and Marginal Revenue Average Revenue Curve: Total revenue divided by quantity AR = TR/Q = P x Q/Q = P Average revenue and price are the same Marginal Revenue (MR): Addition to total revenue resulting from the addition of one unit of output. Slope of the TR curve. TR = P x Q Maximization of Total Profit What combo of output and money will give the most profit? TP = RR TC Marginal analysis applies to every part of the circular flow Profit Maximization: A Graphical Interpretation TP falls negative at too much output Total profit curve is shaped like a hill On a total revenue and total cost graph, the distance between TR and TC is the total profit Marginal Analysis and Maximization of Total Profit Marginal Profit: Addition to total profit resulting from one more unit of output An output level maximizes profit when the marginal profit is at zero Marginal profit is the slope of the total profit curve Slope of zero on total profit curve = max profit An output decision cannot be optimal unless the corresponding marginal profit is zero Marginal Revenue and Marginal Cost: Guides to Optimization When TR and TC slopes are equal total profit is maximized Profit can be maximized only at an output level at which marginal revenue is approximately equal to marginal cost Marginal profit is the slope of the total profit curve Marginal revenue is the slope of the total revenue curve MR = MC Where profit can be maximized

Finding the Optimal Price from Optimal Output Profit maximizing output quantity has been determined with the help of the MR = MC rule, it is easy to find the profit maximizing price with the help of the demand curve. Just use that curve to find out at what price the optimal quantity will be demanded. Generalization: The Logic of Marginal Analysis and Maximization Net gain the difference between total benefit and total cost If a decision is to be made about the quantity of some variable, then to maximize: Net benefit = total benefit total cost The decision maker must select a value of the variable at which: Marginal benefit = Approximately marginal cost Application: Fixed Cost and the Profit Maximizing Price When a firms fixed cost increases, its profit-maximizing price and output remain completely unchanged, so long as it pays the firm to stay in business Conclusion: The Fundamental Role of Marginal Analysis Output and pricing Applies to everything with scarce resources Women in universities The Theory and Reality: A Word of Caution People often go by insight or hunches