10.1 Short-Run Profit Maximization

Question 1

What is marginal revenue?

Answer 1

Incremental revenue produced by generating one additional unit of product

Question 2

What is marginal cost?

Answer 2

Additional cost incurred by generating one additional unit of output

Question 3

Profit maximization point

Answer 3

MR = MC

Question 4

A small delivery company received an order that requires nine deliveries lasting two hours each on the same day. The company owns two vans that together can make eight trips per day. The company can rent a van on a daily eight-hour basis for $72, and the fuel cost is $20 per trip. The company has several van drivers, each of whom earns $30,000 annually and is expected to make 1,000 deliveries each year. The marginal cost of the ninth delivery is

A. $122
B. $92
C. $38
D. $28

Answer 4

B. $92

Marginal cost is the additional cost of producing one more unit of output. If the company makes the ninth delivery, it will incur $72 to rent a van and $20 fuel cost. Van drivers’ salaries are fixed costs and will not change by additional delivery. Thus, the marginal cost of the ninth delivery is $92 ($72 + $20).

Question 5

A firm produces only 5 units of output. If total variable cost is $400 and total fixed cost is $200, then

A. Marginal cost is $120.
B. Average total cost is $600.
C. Average fixed cost is $200.
D. Average variable cost is $80.

Answer 5

D. Average variable cost is $80.

If total variable cost is $400 for 5 units, the average variable cost is $80. The average fixed cost is $40 ($200 ÷ 5), and the average total cost is $120 ($80 + $40).

Question 6

At the current output level the price is $10, the average variable cost is $6, the average total cost is $10, and marginal cost is $8. To maximize profits, a consultant would recommend that the firm should

A. Decrease production.
B. Not change production.
C. Increase production.
D. Shut down.

Answer 6

C. Increase production.

A firm should continue increasing production as long as marginal cost is less than selling price. Profit is maximized when marginal cost equals selling price. (In pure competition, selling price is the same as marginal revenue.)

Question 7

Average Total Cost (ATC)

Answer 7

Average Total Cost (ATC) = (Total Variable Cost + Total Fixed Cost) ÷ Quantity
= (TVC + TFC) ÷ Q

Question 8

An organization’s sales revenue is expected to be $72,600, a 10% increase over last year. For the same period, total fixed costs of $22,000 are expected to be the same as last year. If the number of units sold is expected to increase by 1,100, the marginal revenue per unit will be

A. $6
B. $46
C. $4
D. $20

Answer 8

A. $6

Marginal revenue (MR) is the incremental revenue for each additional unit sold (increase in revenue ÷ increase in units sold). If expected revenue of $72,600 is a 10% increase over that for the prior year, the prior year’s revenue must have been $66,000 ($72,600 ÷ 110%).
MR = ($72,600 – $66,000) / 1,100
= $6,600 / 1,100
= $6

Question 9

Formula for marginal revenue

Answer 9

Increase in revenue ÷ Increase in units sold