Chapter 22   Analyzing Profit
A more concise One-Page Review of Chapter 22
may help with exams.  Updated 9/9/17
 


 I. Introduction
II. Demand Determines Marginal Revenue.
III. Maximizing Profit Using Marginal Analysis
IV. Maximizing Profit With Total Revenue & Cost 
V. Minimizing a Short- Run Loss, Short-Run Close Down

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. Imperfect Competition MR Less Than Demand
     E. The special case of horizontal perfectly elastic
         demand will be explored in chapter 23.

 

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 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.

 

VI. Economies and Diseconomies of Scale  Affect Profit
VII Long-Run Costs
VIII. Predicting profit with break-even analysis    
IX. Is U.S. Free Enterprise Working

Many Seek an Advantage
Rent is considered excess profit.

   

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.

 
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, this analysis uses total analysis.

Our Free Internet Libraries improve grades and careers.

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.

 

 

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

The Economist Magazine 5/4/13

 

 

Efficiency Keeps Job Growth Down

Increase

 % Increase

Relative Change

98,000 jobs 544%

 

     
$196.32 billion

1016%

Sales increased almost twice jobs.
$43.7 billion 2196% Profits increased about four times jobs
$231.2 billion 3618% Cash increased about six times jobs
     
    Unlike other comparisons, maintaining margin with growth can be difficult
10.1 % points           35%
$9.33 billion 1314%

R&D increased more than twice jobs.

     
Source: @WSJ; 
Read full article
 

VII Long-Run Costs

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

     B. Sustainable growth of the U.S and Incremental Capital Output Rate

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
         C. 
Oil Shale Production, Breakeven and Marginal Costs,  Moving the Goalposts

      D.  Financial Accounting For Owners, Managers, and Administrators

Practice Quiz

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

Please 

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 plantation 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 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 Manicure Conway, noting Jefferson’s enduring reputation as a would-be emancipator, remarked scornfully, 'Never did a man achieve “Never did a man achieve mo re fame for what he did not 
do.' ”  
smithsonianmag.com

 

Thomas Jefferson Illustration

 

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