Amherst College Department of Economics Economics 111 Section 5 Fall 2015 Name: P.O. Box: Micro Assignment 12: Marginal Cost and Profit Maximization 1. The results from our previous assignment appear below: Quantit y Margina l Cost Marginal Cost (MC) 100 $5.00 500 150 $40.00 200 $105.00 400 250 $200.00 $325.00 350 $480.00 200 MC MR = 100 100 150 200 250 350 Suppose that the price equals $. a. What does the firm s marginal revenue equals? $ b. Plot the firm's marginal revenue curve on the diagram above. c. Suppose the firm produces 200 units of output. 1) What does the firm's marginal cost equal when it produces 200 units of output? $105 2) Does the production of 200 units maximize the firm's profits? Yes No X. If not, what should the firm do to increase profits? Produce More X Produce Less. Explain. $.00 $105.00 Produce 1 more unit of output Total revenue rises by $.00 Total cost rises by $105.00 Profits rise by the difference, $195.00
2 d. Now, suppose that the firm produces 250 units. 1) What does the firm's marginal cost equal when it produces 250 units of output? $200 2) Does the production of 250 units maximize the firm's profits? Yes No X If not, what should the firm do to increase profits? Produce More X Produce Less. Explain. $.00 $200.00 Produce 1 more unit of output Total revenue rises by $.00 Total cost rises by $200.00 Profits rise by the difference, $100.00 e. Last, suppose that the firm produces 350 units. 1) What does the firm's marginal cost equal when it produces 350 units of output? $480 2) Does the production of 350 units maximize the firm's profits? Yes No X. If not, what should the firm do to increase profits? Produce More Produce Less X. Explain. $.00 $480.00 Produce 1 less unit of output Total revenue falls by $.00 Total cost falls by $480.00 Profits rise by the difference, $180.00 f. In general, to increase profit should the firm produce more or less when a. marginal revenue is greater than marginal cost? More X Less b. marginal revenue is less than marginal cost? More Less X c. What two pieces of information do you need to determine the firm s profit maximizing quantity? Marginal Revenue (MR) and Marginal Cost (MC)
3 2. Recall that on January 1, 2015, Jeff Lord resigned from Arthur Anderson to start his own consulting firm. On that date: He signed a one-year lease for office space. The one-year lease legally requires Jeff to pay his landlord $20,000 per month in rent until January 1, 2016. He hired several employees whose wages summed to $35,000 a month. All other out-of-pocket costs that Jeff incurs are negligible. Immediately after Jeff began his business he acquired several loyal clients. Jeff charges his clients $650 per hour and records 100 billable hours. In total, Jeff collects $65,000 from his clients each month. Summarize the financial state of Jeff s firm below: Total Revenues: $65,000 per month Rent: $20,000 per month Employee Wages: $35,000 per month a. How much income has Jeff earned each month from operating his firm? 65,000 (20,000 + 35,000) = 65,000 55,000 = 10,000 Until January 1, 2015, he worked for Arthur Anderson as a consultant earning a salary of $25,000 a month. Jeff departed from Anderson on very good terms; the management at Anderson told him that he could return to their firm anytime at his old salary. As you know, Jeff is now having second thoughts about leaving Arthur Anderson. He is contemplating the possibility of not renewing his lease on January 1, 2016, going out of business at that time, and returning to his former employer. b. How much monthly income would Jeff be able to enjoy in 2016 if he did not renew his lease on January 1, 2016, goes out of business, dismisses his employees, and returns to Anderson? $25,000 c. Would you expect Jeff to go out of business on January 1, 2015 and return to his job at Anderson? Yes X No. Explain. If he goes out of business and returns to Anderson, he would enjoy his $25,000 per month salary. On the other hand, if he renews his lease and continues to operate his firm, he will earn only $10,000 per month. Clearly, he is better off by going out of business on January 1, 2016.
4 3. The table and graph below reproduce results from a previous lab: Marginal Cost Average Total Cost 100 $5.00 $380.00 150 $40.00 $260.00 200 $105.00 $212.50 250 $200.00 $200.00 $325.00 $210.00 350 $480.00 $221.63 Marginal Cost (MC) 500 400 200 MC ATC 100 100 150 200 250 350 Run the Cost Curves simulation in our lab by clicking on the red computer icon. Micro Problem Lab 12.1: Marginal Cost and Average Total Cost a. Add the values to the average total cost column of the above table, plot the average total cost points, and then sketch the average total cost curve by drawing a smooth curve through the average total points b. Does the average total cost curve rise or fall when 1) marginal cost is less than average total cost? Rise Fall X 2) marginal cost is greater than average total cost? Rise X Fall c. How are average total cost and marginal cost related at the lowest point on the average total cost curve (minimum average total cost)? Marginal cost and average total cost are equal.
5 4. Consider a small seminar at Amherst. At the beginning of the class only two students are present. In total, the two students weigh pounds, so their average weight is 150. After the class begins a third student, Stevie Sims (the precocious two year old son of Professor Sims) arrives. Stevie weighs 30 pounds. Question: Will the average weight of the students in the class rise or fall? Fall Apply your intuition. Since the weight of the additional student (Stevie) is below average, he should pull the average down. Next, a fourth student, Casey Hampton, arrives; Casey is the former nose tackle for the six time Super Bowl champion Pittsburgh Steelers. He weighs about 320 pounds. Question: Will the average weight of the students in the class rise or fall? Rise Apply your intuition. Since the weight of the additional student (Casey) is above average, he/she should pull the average up. Confirm your intuition by filling in the following blanks: Total Average Next Student s Weight Weight Weight Original Two Students 2 = 150 All Three Students 330 All Four Students 650 330 3 650 4 = 110 = 162.5 30 3 rd Student 320 4 th Student