Price and Profit Equal to Marginal Cost

Question: Describe about the Price and Profit for Equal to Marginal Cost. Answer: a: The Marginal Cost of cinema is $4. The price is set where Marginal Benefit is equal to Marginal Cost. The monthly benefit of the market is calculated in the following table. Marginal Benefit (Dollar per Movie) greater than or Equal to: Movie Sales per Month REY FINN Market 75.00 1 0 1 30.00 1 1 2 25.00 1 2 3 20.00 1 3 4 15.00 1 4 5 10.00 2 4 6 0.00 3 4 7 Here, the movie is a discrete good. Therefore, the marginal benefit is the demand for the consumer and the market benefit is the market demand. The Profit maximizing price will be $20 per movie. At the profit maximizing price, $20, Rey will buy 1 movie ticket and Finn will purchase 3 movie tickets. Consumer Surplus of a discrete good can be obtained by adding the difference between the willingness to pay and the actual price paid (Bergemann, Brooks and Morris 2014). Consumer surplus of Ren will be, (75-20) = $55 Consumer Surplus of Finn will be, (30-20)+ (25-20)+ (20-20) = 10+5= $15 2b: A new consumer Poe, enters the market. Marginal Benefit (Dollar per Movie) greater than or Equal to: Movie Sales per Month REY FINN POE Market 75.00 1 0 0 1 30.00 1 1 1 3 25.00 1 2 2 5 20.00 1 3 3 7 15.00 1 4 4 9 10.00 2 4 4 10 0.00 3 4 4 11 The profit maximizing price will is set where Marginal Benefit is equal to Marginal Cost (Kulkarni 2014). However, in the above table, there is no value of marginal benefit equal to 4. The firm will not sell at a price where marginal cost is higher. Therefore, it will sell movie tickets at $30 and 3 tickets will be sold. Number of tickets purchased by Rey; Finn and Poe are 1, 1 and 1 respectively. Consumer surplus of Ren will be, (75-30) = $45 Consumer Surplus of Finn will be, (30-30) = $0 Consumer Surplus of Poe will be, (30-30) = $0 The increase in price can be explained by the increase in demand for each unit of price. Rise in demand has led to rise in profit maximizing or equilibrium price. Since more consumers have entered the market, the consumer surplus of Ren has fallen as benefit is getting shared. Moreover, due to increase in the price, the consumers well being has been reduced. They have to pay more for each unit of movie ticket than it used to pay in last month. In the last month, profit-maximizing price was $20 and number of movie ticket was 4. Therefore, the total revenue was ($20 * 4) = $ 80. In this month, profit-maximizing price is $30 and number of movie ticket sold is 3. Therefore, the total revenue is ($30 * 3) = $ 90. The change in revenue is positive and by an amount of (90-80) = $10 and change in cost due to fall in number of ticket sold from 4 to 3, is fall in cost by $4. Therefore, the profit will be more when there is an extra consumer in the market. The increase in price for each unit is the reason behind the rise in cinemas profit. Addition of extra customer will never cause firms profit to fall, as the marginal cost is constant. As a new consumer enters the market, then price for each unit will be increased. If the MC is increasing then after a certain price, profit will be decreased (Roach 2013). This is because, as cost of producing extra unit increases, incentive for the firm will be declined, as net profit will tend to fall and as more price is charged the less quantity will be demanded that is also reduces the profit earned by the firm. The fixed cost remains same and hence, it has no impact in the marginal cost. Therefore, in the above, the calculations are done with the help of marginal cost only. Marginal cost reflects the changes in variable costs of production. 2c: The profit maximizing strategy of cinema of Jakku village enjoys the monopoly. Hence, its price will be set where marginal benefit will be higher than the marginal cost. Therefore, the firm will charge price equal to or more than $20. The profit maximizing strategy of cinema of DQar village has only one consumer. Hence, Poes marginal benefit is the market demand. The firm will charge a price higher than $15 for each movie, as at this price MB=MC. Dollar per Movie MB of Poe 75.00 0 30.00 1 25.00 2 20.00 3 15.00 4 10.00 4 0.00 4 3a: The fixed cost is $10 and marginal cost is $3. The profit maximizing bundles that the firm will sell will charge different price for Han and other price for Luke and Leia. For Han, the profit-maximizing price can be calculated as follows. Quantity Price Revenue (P x Q) Variable Cost (MC x Q) Profit (Revenue- Cost) 1 16.00 16 3 13 2 10.00 20 6 14 3 4.00 12 9 3 4 0 0 12 -12 5 0 0 15 -15 Here, profit is maximized when price is $10 selling 2 units of that good. Now, for Luke and Leia together, the market demand and the revenue; variable cost and profit are shown in the following table. Price Luke Leia Market Revenue (PxQ) Variable Cost (MC x Q) Profit (Revenue- Cost) 24 1 0 1 24 3 21 20 1 1 2 40 6 34 18 2 1 3 54 9 45 14 2 2 4 56 12 44 12 3 2 5 60 15 45 8 3 3 6 48 18 30 6 4 3 7 42 21 21 2 4 4 8 16 24 -8 0 4 5 9 0 27 -27 The profit is maximized at two points. Hence, the firm can charge either $18 for 3 units or $12 for 5 units. Hence, the profit maximizing bundles will be either 2 units for Han (at $10) and 3 or 5 units (at $18 or $12) for Luke and Leia. Consumer Surplus for Han will be,(16-10)+ (10-10) = $6 Consumer Surplus for Luke when price is $18 will be, (24-18) + (18-18) = $6 Consumer Surplus of Leia when price is $18 will be, (20-18) = $2 OR, Consumer Surplus for Luke when price is $12 will be, (24-12) + (18 12) + (12-12) = $18 Consumer Surplus of Leia when price is $12 will be, (20-12)+ (14- 12) = $10 The primary reason of getting different consumer surplus is that the willingness to pay for each consumer is different (Baumol, W. and Blinder 2015). Another reason is that the firm charges discriminating price for the consumers. It charges low price for Han, as he is a student and charges different price for Luke and Leia. 3b For Luke, the profit-maximizing price can be calculated as follows. Quantity Price Revenue (P x Q) Variable Cost (MC x Q) Profit (Revenue- Cost) 1 24 24 3 21 2 18 36 6 30 3 12 36 9 27 4 6 24 12 12 5 0 0 15 -15 Here, profit is maximized when price is $18 selling 2 units of that good. Now, for Han and Leia together, the market demand and the revenue; variable cost and profit are shown in the following table. Price Leia Han Market Revenue (P x Q) Variable Cost (MC x Q) Profit (Revenue- Cost) 20 1 0 1 20 3 17 16 1 1 2 32 6 26 14 2 1 3 42 9 33 10 2 2 4 40 12 28 8 3 2 5 40 15 25 4 3 3 6 24 18 6 2 4 3 7 14 21 -7 0 4 4 8 0 24 -24 The profit-maximizing price for Leia and Han will be $14 and 3 units will be sold. Hence, the firm charges lower price for the students. Consumer Surplus of Luke will be, (24-18) + (18-18) = $6 Consumer Surplus of Leia will be, (20-14) + (14-14) = $6 Consumer Surplus of Han will be, (16-14) = $2 3c The total profit is of Firm in part A will be, $14 + $45 - $10= $49, where 10 dollar is the fixed cost. Total profit of firm in part B will be, $30+ $33- $10= $53, where 10 dollar is the fixed cost. The firm earns more profit in part B, because, the there are more people in the low marginal benefit group. Therefore, it can charge considerable higher price from the person with high MB. However, in part A, the person with low MB was affecting the possibility of charging high price from the person with high MB. 3d When Leia and Han do not have identification to show their membership of low marginal benefit group, but Luke has membership of golf club. Hence, in this case, the firm will charge more prices for Luke. It will be similar as the part b for Question 3. The firm would adopt direct discrimination strategy of pricing. The key economic characteristic of the firms pricing scheme is to maximize profit by charging high price from the consumer who has high marginal benefits (Cowan 2012). This is the third-degree price discrimination. When the firm raises price, while enabling direct price discrimination for the high demand consumers, it helps to extract more surplus as profit (Maurice, S.C. and Thomas 2015). Since the calculation will be same as part b of question 3, it can be said the in this case the profit of the firm will be similar as found in part B, i.e., $53, which is greater than the profit earned in case of part a. 4a MB Snoke Quality Kylo Quality Total 6.5 1 0 1 4.5 2 0 2 3.5 2 1 3 3 3 1 4 2 3 2 5 1.5 3 3 6 1.25 3 4 7 0.5 4 4 8 0.25 4 5 9 The firm will perceive the Snoke and Kylo quality together and by considering total demand at each price level, it will be able to maximize its profit. MB = MC is the condition for profit maximization. However, since MC is not given the profit maximizing price and output cannot be obtained from the above table. 4b: Since the price of coffee beans are rising it implies that, the cost of input is increasing. The economic theory suggests that the price of the product will also increase in order to maintain its level of profits. Hence, the argument of increasing price of the cup of coffee is economically feasible. Since the cost incurred by the coffee shop cannot be reduced, it has only one way to maintain its profit level, i.e. to increase the charge. The profit of the firm is the difference between Revenue and total cost (Hildenbrand 2014). If total cost has been increased, then to maintain the same profit level the firm has to increase its revenue by charging higher price. The rise in coffee beans price is expected to last only for one month. Hence, the coffee shop may not wish to increase its price as the change is only for a short term. If the price would have increased permanently or for a long time, then to maintain the profit level the coffee shop would have wished to raise the price of the cup of coffee. However, if the elasticity of demand for coffee is too high, then rise in the price of cup of coffee will lead to significant fall in demand (Mankiw 2015). If this happens, then the firm will incur a severe loss in spite of charging a high price due to hike in the input cost. Therefore, the firm can wait for a month and charge same price for cup of coffee. In contrast in the demand is too inelastic then rise in price will not affect the demand made by consumers. As a result of this, the firm can generate significant profits by charging high price when the cost of coffee beans have gone up. References Baumol, W. and Blinder, A., 2015.Microeconomics: Principles and policy. Cengage Learning. Bergemann, D., Brooks, B.A. and Morris, S., 2014. The limits of price discrimination. Cowan, S., 2012. Third Degree Price Discrimination and Consumer Surplus.The Journal of Industrial Economics,60(2), pp.333-345. Hildenbrand, W., 2014.Market demand: Theory and empirical evidence. Princeton University Press. Kulkarni, K.G., 2014. Principles of Microeconomics. Mankiw, N.G., 2015. Principles of Microeconomics, Cengage Learning. Maurice, S.C. and Thomas, C., 2015.Managerial Economics. McGraw-Hill Higher Education. Roach, T., 2013. Principles of Microeconomics.