The Mechanics of Profit Maximization •Profit maximization –Continue expanding output until •The value society places on the last unit sold •Just equals the amount spent on resources to produce that...

Melissa Buehrlen
Instructor Somers
Business Economics
06/11/2013
Chapter 14; Exercise Questions
1. Describe profit maximization in terms of marginal revenue and marginal cost.
Any profit maximizing firm would operate at an output level where marginal revenue from the
last unit sold equals the marginal cost of its production. It must be noted that profit is nothing but
difference between total revenue and total cost, and this is the level where the difference between
the total revenue and the total cost is maximum, where the slopes of these two curves are equal.
Beyond this point the gap between total revenue and total cost declines as the marginal cost
exceeds marginal revenue, so the firm surpasses the profit maximizing level. Hence, profit
maximization is at the level where the value society places on the last unit sold just equals the
amount spent on resources to produce that unit.
2.) Explain what is different between firms in monopolistic competition and firms in
oligopoly. What does the difference mean for prices and quantities and for economic
profit?
The main difference between monopolistic competition and oligopoly is that oligopoly
market structure contains small number of large firms with significant ba
iers to entry,
whereas, monopolistic competition market structure contains large number of small firms
with free entry and exit. It appears that there is more price setting discretion in oligopoly
since a few large firms control the market, and they can earn excess profits, whereas in
monopolistic competition due to large number of firms there is less freedom to set prices,
so heterogeneity of the good can be used to control the quantity sold, but there is
comparatively less possibility of earning excess profits, but as compared to perfect
competition, monopolistic market structure also involves above normal profits.
3.If the (profit-maximizing) level of output that a monopolist produces is such that
marginal revenue, marginal cost, and average total cost are equal, then economic profits
must be:
a.) negative.
.) positive.
c.) zero.
d.) indeterminate from the given information.
.) Positive, because it is known that in monopoly the average revenue curve is downward
sloping and marginal revenue curve always lies below it, so when MR=MC=ATC and AR>MR,
so AR>ATC, and hence there are positive economic profits.
Chapter 15; Exercise Questions
1.) Explain why marginal revenue is less than or equal to price. How does the
difference between price and marginal revenue depend on the price elasticity of
demand?
Since the total revenue curves are either upward sloping straight lines or upward sloping
curves with diminishing slope. If the total revenue curves are straight lines then the
marginal revenue and average revenue is equal. If the total revenue curve is upward
sloping curve with diminishing slope then the average revenue is always greater than the
marginal revenue. This is because the value the society attaches to each unit will be less
than the previous unit consumed, so marginal revenue is less than the price of that unit
and hence marginal revenue is less than or equal to average revenue.
TR = P.Q
MR =dTR/dQ
MR = P + (dP/dQ)Q
MR = P(1 + 1/e)
MR – P = P/e
So, the difference between price and marginal revenue depends on price elasticity of
demand.
2.) Why would a firm not want to price at the point where marginal revenue is greater
than marginal cost?
If a firm prices at the level where marginal revenue exceeds marginal cost then it forgoes
some potential profits. It can be well understood that if the marginal revenue is greater
than marginal cost, then it means that net addition to revenue from one more unit sold is
greater than the net additional cost of producing one more unit, so it is profitable to
produce one more unit. So, at level where marginal revenue exceeds marginal costs, there
exist potential profits which can be tapped by increasing output, up till the level where
marginal revenue equals marginal cost.
3.) Some personal computer software is sold at special discounts to students. Other
software is provided in a less powerful version for students. Why do publishers
offer discounts to students? What is the purpose of developing less powerful
editions?
It may be the case that due to monopoly pricing or some other pricing strategies there may be a
set of consumers, here students who wish to buy the personal computer software but cannot
afford price as high as monopoly price. So, the firm may price discriminate...