. © 1999 - 2004
Douglas A. Ruby


A Producer Optimum

Production Costs

Profit Maximizing Behavior

Microeconomics
Tutorial: Profit Maximization

1) Use the mouse to drag the green triangle along the horizontal axis, left or right to simulate changes in output. Try to determine the profit maximizing level of output.
2) Press the 'Details' button to check your results.
3) Use the mouse to drag the green triangle along the vertical axis, to drag the Price line 'D' up or down and then repeat steps 1) & 2).
4) Press 'Reset' to start over.


Answers are Below:

A. Given a market price Pmkt of $8.00:

(i) What is the profit-maximizing quantity for the firm? Press 'Details'. What are the numeric values of Total Revenue, Total Costs, and Profits?

(ii) If you reduce the available quantity by 1,000 units (drag the green triangle left along the horizontal axis), what will be the change in Total Revenue and Total Costs? What is the effect on Total Profits? Explain.

B. Press Reset and then change the market price P'mkt of the good to $10.00.

(i) Given this price change, explain why profits are not being maximized at the quantity of 4,000 units?

(ii) Graphically try to find the profit maximizing quantity for this price of $10.00. Confirm or determine exact results by pressing the 'Details' button.

C. Repeat part B. for a market price of $4.00. Discuss your results.
Answers...

A. i. At a market price 'Pmkt'of $8.00, the profit maximizing quantity is 4,000 units. At this quantity, Pmkt = MC or, in words, the revenue from selling the last unit is just equal to the costs of producing that last unit. At this price-quantity combination:
Revenue (TR) = $32,000
Costs (TC) = $26,000 = $10,000 + 0.001(4,000)2
Profits = $6,000
ii. By reducing the quantity by 1,000 units (ΔQ = -1,000) the following occurs:
ΔRevenue = -$8,000
ΔCosts = -$7,000 and
ΔProfits = -$1,000
Both revenue and costs decline. However, there is a larger decline in revenue relative to costs -- profits decline.

B. (i) When the market price 'P'mkt' increases to $10.00, holding the quantity at 4,000 units, results in a situation where: Pmkt > MC or, in words, the revenue from selling one more unit is greater than the costs of producing an additional unit. The firm can increase profits with increased production and sale of this good.

ii. The profit maximizing quantity is 5,000 units. At this price-quantity combination:
Revenue (TR') = $50,000
Costs (TC') = $35,000 = $10,000 + 0.001(5,000)2
Profits = $15,000
These values represent the best that the firm can do given a market price of $10.00

C. (i) When the market price 'P"mkt' increases to $4.00, holding the quantity at 4,000 units, results in a situation where the firm is experiencing losses (TR < TC). Additionally, Pmkt < MC or, in words, the revenue from selling one more unit are less than the costs of producing an additional unit. The firm can increase profits, or more accurately, reduce its losses with reduced production and sale of this good.

ii. The profit maximizing (loss-minimizing) quantity is 2,000 units. At this price-quantity combination:
Revenue (TR') = $8,000
Costs (TC') = $14,000 = $10,000 + 0.001(2,000)2
Losses = -$6,000
These values represent the best that the firm can do given a market price of $4.00. At such a low market price, revenue is always less than production costs (see the diagram on the right) thus losses occur over the entire range of production.