Business: Profit Maximization and Total Profit Essay

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Assignment 1 ECO10250 – Answer Sheet 2008

Question 1

a) There are two parts to this answer. Firstly students should draw a properly labeled demand graph with a rightward movement from Do to D1 demonstrating a shift in demand (increase) due to expectations of a price change which will flow from a future tax increase. Secondly students should then draw an upward movement along D1 to demonstrate a decrease in demand flowing from the actual tax increase. The amount of marks awarded will depend on the graphical demonstration and supporting discussion that the students provide. This will be the case for answers (b-c) below. (2 Marks)
b) A leftward movement of the demand curve from Do to D1 as price has not changed but demand will decrease due to the increased price of oil being a complement to a car. (2 Marks)
c) A rightward movement of the demand curve from Do to D1 as price has not changed but demand for new cars will increase as owners replace 4 year old cars with new cars at a greater rate than before due to extra costs associated with pollution. (2 Marks)

Question 2

(a) See the following table: (1 Mark) Output
1
2
3
4
5
6
7
8
9
10
AC ($)
7.00
5.00
4.00
3.30
3.00
3.10
3.50
4.20
5.00
6.00
TC ($)
7.00
10.00
12.00
13.20
15.00
18.60
24.50
33.60
45.00
60.00
MC ($)

3.00
2.00
1.20
1.80
3.60
5.90
9.10
11.40
15.00
AR ($)
10.00
9.50
9.00
8.50
8.00
7.50
7.00
6.50
6.00
5.50
TR ($)
10.00
19.00
27.00
34.00
40.00
45.00
49.00
52.00
54.00
55.00
MR ($)

9.00
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00 (b) Profit is maximised where MC=MR: at an output of 6. (1 Mark) (c) Total profit equals TR–TC.
At an output of 5, total profit is $40.00 – $15.00 = $25.00.
At an output of 6, total profit is $45.00 – $18.60 = $26.40.
At an output of 7, total profit is $49.00 – $24.50 = $24.50. Profit rises up to 6 units of output and then falls. Profit is thus maximised at 6 units: it is $26.40 per period of time. (1 Mark) (d) See Figure A5.1

Figure A5.1 Profit Maximisation for a firm facing a downward-sloping demand curve (1 Mark) (e) See Figure A5.1. Profit is maximised where MC = MR, at an output of 6. At this output, AR = $7.50 (point a); AC = $3.10 (point d). (1 Mark) (f) This area is shown by the rectangle abcd in Figure A5.1. (1 Marks)

Question 3

Discussion question 4 p 132
Chapter 6 pages 116-121 outline the answer to this question along with graphical demonstration (3 Marks)

Discussion question 1 p 157

Price
($)
Quantity demanded
Total revenue
($)
Marginal revenue ($)
200
20
4000

185
195
30
5850

175
190
40
7600

165
185
50
9250

130
180
55
9900

120
175
60
10500

(a) As in first two columns above.
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