Chapter 22   

Analyzing Profit

Index

 I. Introduction
II. Demand Determines Marginal Revenue.
III. Maximizing Profit Using Marginal Analysis
IV. Maximizing Profit With Total Analysis of Revenue & Cost
V. Minimizing a Short- Run Loss Versus a Short-Run Close Down
VI. Economies and Diseconomies of Scale  Affect Profit.
VII Long-Run Costs
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Homework Questions
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 I. Introduction
   
A. Profit equals total revenue minus total costs.
    B. Understanding profit requires bringing revenue and costs together.
   
C. Total profit and profit on the margin will be analyzed.

 II. Demand Determines Marginal Revenue.
      A. Marginal revenue (MR) is the change in total revenue which is received from selling
           one more unit. 
      B. Demand may be thought of as average revenue with what is happening on the margin
           an indication of what is happening to the average.
      C. When product demand is downsloping, marginal revenue is below demand indicating
          the average price received falls as quantity increases.
      D.
Econ Concepts in 60 Seconds Video on Imperfect Competition MR Less Than Demand

 

 

 

 

Total GDP has returned to per recession levels but employment might not do so for another five years. Follow the theory in this chapters has allowed companies to maintain profits, but another recession could spell trouble for profit and employment. businessinsider.com 09/27/12

image

   E. The special case of horizontal perfectly elastic demand will 
       be explored in chapter 23.
Demand Schedule    
Price Quantity Total Revenue Marginal Revenue
5 0 0  
4 1 4 4
3 2 6 2
2 3 6 0
1 4 4 -2
At high prices, demand is inelastic, lowering price increases total revenue as marginal revenue is positive.

At medium prices, unitary elasticity means no change in total revenue as price is changed.

At low prices, demand is elastic, lowering price decreases total revenue as marginal revenue is negative.

 

III. Maximizing profit using marginal analysis
       A. Selling quantity Q will maximize profit.
       B. At quantities below optimum point Q, MR
            exceeds MC and increasing quantity sold
            will increase total profit.
       C. At quantities above point Q, MC exceeds MR
            and an increase in quantity sold will decrease
             total profit.
       D. Maximum profit results when MR = MC
      
E. To find total revenue (TR) draw a perpendicular
            line from the intersection of MR and MC to the
            quantity axis. Then extend the line up to the
            demand curve and over to the y-axis. The
            resulting rectangle is P x Q which equals
            total revenue.
       F. To find TC draw a line from the intersection
            of the perpendicular and ATC to the y-axis.
            The resulting rectangle is ATC x Q which is
            total costs.
       G. The resulting top rectangle is TR-TC. It is total profit.

IV. Maximizing profit with total analysis of revenue & cost

      Total Revenue = Price x Quantity

      Total Costs = Total Fixed Costs + Total Variable Costs

      Total Profit = Total Revenue - Total Costs

      Maximum profit is where the vertical distance between
      TR and TC is the longest.

 

V. Minimizing a short-run loss versus a short-run
     close down


     A. TR1 is making a profit.

     B. TR2 is paying all variable costs and making some 
          contribution
to fixed costs. Cash flow may be 
          positive as fixed costs such as depreciation, 
          though an expense, have been paid. This level 
          of total revenue is all that is necessary to continue 
          in business during the short run.

     C. TR3 is not covering all variable costs and not 
          contributing to fixed costs. This situation requires 
          that the firm shut down very quickly in the short run
          as each unit produced adds to total loss.

Econ Concepts Video in in 60 Seconds,
The Shut Down Rule

Editors Note: Video uses marginal analysis while this analysis uses total analysis.

 

US adjusted to maximize profit by becoming a lean production machine.

The Economist Magazine 5/4/13

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VI. Economies and Diseconomies of Scale  Affect Profit.
      A. Companies try to maximize profits by designing 
           production
facilities that increase the number of 
           units produced before the diseconomies of scale
           begin to rapidly increase costs.

      B. Flexible production lines, designed by the 
          Japanese and being used by companies such as
          General Motors, allow for producing different 
          product models and even different products 
          without substantially changing a production 
          line's configuration. These procedures have
          become a popular method of increasing a
          plant's economies of scale.

 

 

 

x

VII Long-Run Costs

Long-run average total costs are the
horizontal summation   of ever larger short-run average
total costs.

 

 

 

 

 

 

 

 

VIII. Predicting profit with break-even analysis  
         A. Darin Jones has decided to open a  fully automated  car wash with
 
              Linda Smith, a friend from college. Speedy Car Wash would be fully
              automated with annual fixed charges for costs such as depreciation 
              and rent amounting to $100,000. Variable costs such as labor were
              expected
to be $2.00 per vehicle washed. Price was expected to
              average $7.00 per vehicle and they plan to wash 30,000 cars per year.
              The expected first-year profit for Speedy Car Wash would be calculated
              as follows.
B.  Total Profit 

      = Total Revenue - Total Costs

      = P x Q - ( TFC + TVC)

      = P x Q - TFC + VC/unit X Q

      = ($7/u) X 30,000u - ($100,000 + $2 X 30,000u) 

      = $210,000 - ($100,000 + $60,000) = $50,000

IX. After reviewing cost definitions, this Break Even calculator is a good application of this analysis.

Practice Quiz

Amosweb Practice Test by Specific Topic chose production, answers provided.

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The Dark Side of Thomas Jefferson

A new portrait of the founding father challenges
the long-held perception of Thomas Jefferson
as a benevolent slaveholder

... "The very existence of slavery in the era of the American Revolution presents a paradox, and we have largely been content to leave it at that, since a paradox can offer a comforting state of moral suspended animation. Jefferson animates the paradox. And by looking closely at Monticello, we can see the process by which he rationalized an abomination to the point where an absolute moral reversal was reached and he made slavery fit into America’s national enterprise."...

"The critical turning point in Jefferson’s thinking may well have come in 1792. As Jefferson was counting up the agricultural profits and losses of his plantatio in a letter to President Washington that year, it occurred to him that there was a phenomenon he had perceived at Monticello but never actually measured. He proceeded to calculate it in a barely legible, scribbled note in the middle of a page, enclosed in brackets. What Jefferson set out clearly for the first time was that he was making a 4 percent profit every year on the birth of black children. The enslaved were yielding him a bonanza, a perpetual human dividend at compound interest. Jefferson wrote, “I allow nothing for losses by death, but, on the contrary, shall presently take credit four per cent. per annum, for their increase over and above keeping up their own numbers.”  His plantation was producing inexhaustible human assets. The percentage was predictable."

 

We can be forgiven if we interrogate Jefferson posthumously about slavery. It is not judging him by today’s standards to do so. Many people of his own time, taking Jefferson at his word and seeing him as the embodiment of the country’s highest ideals, appealed to him. When he evaded and rationalized, his admirers were frustrated and mystified; it felt like praying to a stone. The Virginia abolitionist Moncure Conway, noting Jefferson’s enduring reputation as a would-be emancipator, remarked scornfully, “Never did a man achieve more fame for what he did not do.”

smithsonianmag.com/history-archaeology/The-Little-Known-Dark-Side-of-Thomas-Jefferson

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