Chapter 9 | Pricing for Profits: Marginal Revenue and Marginal Cost

Question 1

Is the Price You See the Revenue You Get? Marginal Revenue

Answer 1

Marginal revenue equals price for price takers and is less than price for price makers. Smart businesses choose actions when marginal revenue is greater than marginal cost.

Question 2

Marginal revenue

Answer 2

— additional revenue from more sales or from selling one more unit.

Question 3

Marginal revenue depends on market structure (how competitive an industry is) and whether a business is a price taker or a price maker.

Answer 3

– Marginal revenue equals price for price-taking businesses in perfect competition.
– Marginal revenue less than price for price-making businesses in all other market structures.

Question 4

One-price rule

Answer 4

— products easily resold tend to have a single price in the market.

– When a price-making business lowers price, it must lower price on all units sold, not just new sales.
– The one-price rule is why marginal revenue is less than price for price makers.

Question 5

Increasing or Constant? Marginal Cost

Answer 5

As output increases, marginal cost increases for businesses operating near capacity or when businesses’ additional inputs cost more. Marginal cost is usually constant for businesses not near capacity.

Question 6

Diminishing returns

Answer 6

— as output increases, decreasing productivity increases marginal costs.

Question 7

businesses operating near capacity, or shifting to more expensive inputs, have increasing marginal costs to increase output.

Answer 7

Businesses not operating near capacity have constant marginal costs to increase output.

Question 8

Recipe for Profits: Marginal Revenue Greater than Marginal Cost

Answer 8

A smart business decision for maximum economic profits involves both quantity and price decisions. The quantity decision is: Produce all quantities for which marginal revenue is greater than marginal cost. The price decision is: Set the highest possible price that allows you to sell that quantity. Key to maximum profits is to focus on marginal revenues and marginal costs, not on total revenues and total costs.

Question 9

Recipe for maximum profits is easiest to follow by first looking at the quantity decision, then the price decision.

Answer 9

– Increase in quantity yields increase in profits if marginal revenue is greater than marginal cost.
– Stop increasing quantity when marginal revenue is less than marginal cost.

Question 10

Once you choose the quantity with maximum economic profits (target quantity), the price part of recipe is to set the highest possible price that allows you to sell the target quantity.

Answer 10

Once you choose the quantity with maximum economic profits (target quantity), the price part of recipe is to set the highest possible price that allows you to sell the target quantity.

Question 11

Intersection of the MR curve and MC curve is the key to the recipe for maximum profits.

Answer 11

Intersection of the MR curve and MC curve is the key to the recipe for maximum profits.

Question 12

Fixed costs

Answer 12

— do not change with the quantity of output produced.

– rent and insurance are examples of fixed costs.

Question 13

Economic profits

Answer 13

= revenues – (obvious costs + normal profits)

Question 14

Divide and Conquer: Price Discrimination Recipes for Higher Profits

Answer 14

Price discrimination is a business strategy that divides customers into groups. Businesses increase profits by lowering the price to attract additional price-sensitive customers (elastic demanders), without lowering the price to others (inelastic demanders).

Question 15

Price discrimination

Answer 15

— charging different customers different prices for the same product or service.

Question 16

Price discrimination breaks the one-price rule. Possible only when business can:

Answer 16

– prevent low-price buyers from reselling to high-price buyers
– control resentment among high-price buyers

Question 17

Most examples of price discrimination involve services, which cannot easily be resold.

Answer 17

Most examples of price discrimination involve services, which cannot easily be resold.

Question 18

Price discrimination increases profits by:

Answer 18

– charging lower price to elastic demand group (lower willingness to pay)
– charging higher price to inelastic demand group (higher willingness to pay)

Question 19

Price-discriminating business estimates marginal revenues and marginal costs for each separate group, then sets prices allowing the sale of all quantities for which marginal revenue is greater than marginal cost.

Answer 19

Price-discriminating business estimates marginal revenues and marginal costs for each separate group, then sets prices allowing the sale of all quantities for which marginal revenue is greater than marginal cost.

Question 20

Are Maximum Profits Good for All? Market Structure and Efficiency

Answer 20

Maximum profits bring efficiency for perfect competition, but inefficiency for market structures with price-making power.

Question 21

Perfect competition, with price-taking businesses, is an efficient market structure.

Answer 21

– Businesses just earn normal profits — economic profits are zero.
– Maximum total surplus (consumer surplus plus producer surplus).

Question 22

All other market structures, with price-making businesses, are inefficient.

Answer 22

– With same inputs, businesses reduce output and raise prices.
– Businesses earn economic profits.
– Total surplus is less than perfect competition because of deadweight loss from reduced output.

Question 23

There are benefits to market structures with price-making power and economic profits.

Answer 23

– Product variety.
– Economic profits finance innovations and creative destruction, improving living standards for all.