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Fixed explicit costs (annually): · Technology (Web design and maintenance) $5,00

ID: 1130875 • Letter: F

Question

Fixed explicit costs (annually):

·       Technology (Web design and maintenance)   $5,000

·       Postage and handling                                   $1,000

·       Miscellaneous                                              $5,000

·       Equipment                                                  $4,000

·       Overhead                                                    $1,000

TOTAL Explicit Fixed Costs (annual)                         $16,000

Fixed implicit costs (annually):

·       Lost wages from job given up (annual)           $50,000

Variable cost = $20 per book.

Part 1:

Assume that the equation for demand is Q = 40,000 – 500P, where

·       Q = the number of cookbooks sold per year

·       P = the retail price of books

Using the information above, fill in the following chart (note that quantity is just the solution of the demand curve above; the first two lines of the table have been completed for you – you need to complete all other lines in the table):

Price

Quantity

Elasticity

Total Revenue

Total Cost

Economic Profit

$10

35,000

---

$350,000

$766,000

-$416,000

$15

32,500

0.1852

$487,500

$716,000

-$228,500

$20

$25

$30

$35

$40

$45

$50

$55

$60

$65

$70

Indicate the maximum profit price and quantity by highlighting those particular values with red font.

Part 2:

After you complete the chart (either fill in the empty boxes in the table above or create an Excel file), copy and paste the table into a Word file. This table should be at the top of your assignment. Then answer the following questions (based on the chart and your understanding of this material) in 600-800 words:

1.     Why, according to an economist, should implicit costs (i.e., lost wages from job given up) be included in the total cost of your product to compute economic profit?

2.     Why does price elasticity of demand change as you move up the demand curve (more specifically, as the price of the product increases)?

3.     Explain in your own words why MR = MC produces maximum profit for a company.

Price

Quantity

Elasticity

Total Revenue

Total Cost

Economic Profit

$10

35,000

---

$350,000

$766,000

-$416,000

$15

32,500

0.1852

$487,500

$716,000

-$228,500

$20

$25

$30

$35

$40

$45

$50

$55

$60

$65

$70

Explanation / Answer

Part A

Price $

Quantity = 40,000-500*P

elasticty e

TR $

TC $

Economic Profit $

10

     35,000

   350,000

   766,000

- 416,000

15

     32,500

-0.1429

   487,500

   716,000

- 228,500

20

     30,000

-0.2308

   600,000

   666,000

-    66,000

25

     27,500

-0.3333

   687,500

   616,000

     71,500

30

     25,000

-0.4545

   750,000

   566,000

   184,000

35

     22,500

-0.6000

   787,500

   516,000

   271,500

40

     20,000

-0.7778

   800,000

   466,000

   334,000

45

     17,500

-1.0000

   787,500

   416,000

   371,500

50

     15,000

-1.2857

   750,000

   366,000

   384,000

55

     12,500

-1.6667

   687,500

   316,000

   371,500

60

     10,000

-2.2000

   600,000

   266,000

   334,000

65

        7,500

-3.0000

487,500

   216,000

   271,500

70

        5,000

-4.3333

   350,000

   166,000

   184,000

Entire calculation:

Price $

Quantity = 40,000-500*P

% change in Q

% change in P

elasticity e

10

           35,000

15

           32,500

-7.14

50

-0.1429

20

           30,000

-7.69

33.33

-0.2308

25

           27,500

-8.33

25.00

-0.3333

30

           25,000

-9.09

20.00

-0.4545

35

           22,500

-10.00

16.67

-0.6000

40

           20,000

-11.11

14.29

-0.7778

45

           17,500

-12.50

12.50

-1.0000

50

           15,000

-14.29

11.11

-1.2857

55

           12,500

-16.67

10.00

-1.6667

60

           10,000

-20.00

9.09

-2.2000

65

              7,500

-25.00

8.33

-3.0000

70

              5,000

-33.33

7.69

-4.3333

TR $ = P*Q

TFC $

Fixed Implicit cost $

TVC $

TC $ = TFC +FIC

Economic Profit $ = TR - TC

   350,000

     16,000

        50,000

   700,000

   766,000

-   416,000

   487,500

     16,000

        50,000

   650,000

716,000

-   228,500

   600,000

     16,000

        50,000

   600,000

   666,000

-      66,000

   687,500

     16,000

        50,000

   550,000

   616,000

       71,500

   750,000

     16,000

        50,000

   500,000

   566,000

     184,000

   787,500

     16,000

        50,000

   450,000

   516,000

     271,500

   800,000

     16,000

        50,000

   400,000

   466,000

     334,000

   787,500

   16,000

        50,000

   350,000

   416,000

     371,500

   750,000

     16,000

        50,000

   300,000

   366,000

     384,000

   687,500

     16,000

        50,000

   250,000

   316,000

     371,500

   600,000

     16,000

        50,000

   200,000

   266,000

     334,000

   487,500

     16,000

        50,000

   150,000

   216,000

     271,500

   350,000

     16,000

        50,000

   100,000

   166,000

     184,000

Price $

Quantity = 40,000-500*P

TR $

TC $

MR

MC

10

           35,000

    350,000

    766,000

15

           32,500

    487,500

    716,000

-55

20

20

           30,000

    600,000

    666,000

-45

20

25

           27,500

    687,500

    616,000

-35

20

30

           25,000

    750,000

    566,000

-25

20

35

           22,500

    787,500

    516,000

-15

20

40

           20,000

    800,000

    466,000

-5

20

45

           17,500

    787,500

    416,000

5

20

50

           15,000

    750,000

    366,000

15

20

55

           12,500

    687,500

    316,000

25

20

60

           10,000

    600,000

    266,000

35

20

65

              7,500

    487,500

    216,000

45

20

70

              5,000

    350,000

    166,000

55

20

A firm will always maximize profits where the marginal revenue equals the marginal cost. In the above table, the firm will continue to increase output up to the point where the marginal cost is equal to the marginal revenue, which in our table occurs at 12,500 units of output. If this frim produces 15000 units, the MC will be higher than the MR.

Explanations for all the columns in table below starting from Left to right:

Price = given in the question

Quantity = put the value of price in the demand function given

Q = 40000 – 500P

For example, P = 10, Q = 40000-500*10 = 35000

P = 15, Q = 40000-500*15 = 32500

Drag the formula, 30000, 27500 and so on….

Elasticity e = % change in quantity demand / % change in Price

To calculate % change in quantity demand for Q 32500 = (32500/35000-1)*100 = -7.14 and drag the formula

To calculate % change in Price for Q 32500 = (15/10-1)*100 = 50 and drag the formula

E = -7.14 / 50 = -0.1429

TR = total Revenue = P*Q = 10*35000 = 350000 and so on

TC = Total fixed cost + Fixed implicit cost + Variable cost

Total Variable cost = 20*Q for every row so first row = 20*35000 = 700000 and then 20*32500=650000

And so on

TFC is given and it will remain same for all the rows

TC = 16000 + 50000 + 700000 = 766000 for first row and then drag

Economic Profit $ = TR - TC

We have TR and TC

MR for Q at 32500 = (487500-350000) / (32500-35000) = -55

Now drag formula

MC for Q at 32500 = (716000-766000) / (32500-35000) = 20

Now drag formula

Part 2:

After you complete the chart (either fill in the empty boxes in the table above or create an Excel file), copy and paste the table into a Word file. This table should be at the top of your assignment. Then answer the following questions (based on the chart and your understanding of this material) in 600-800 words:

1.     Why, according to an economist, should implicit costs (i.e., lost wages from job given up) be included in the total cost of your product to compute economic profit?

First, we should know that Economic profit (EP) is the profit that a firm gets after deducting all its costs.

EP = Explicit costs + Implicit costs

Explicit costs are the compulsory cost of a firm for example wages, salaries rent etc that a firm pays directly.

Implicit costs are the opportunity cost of resources already owned by the firm. Here lost wages from job given up should be included as it is an opportunity cost to a firm and it may have an indirect effect on the business.

2.     Why does price elasticity of demand change as you move up the demand curve (more specifically, as the price of the product increases)?

Since we have downward sloping demand curve (Q = 40000 – 500*P) it says that price and quantity move in opposite direction. When the price of the product increases, the demand for the quantity falls. Price elasticity of demand measures the responsiveness of change in quantity demanded to the change in price of the product. The elasticity of demand between two points, say A and B, on the demand curve would be

Price elasticity of demand = % change in quantity demand / % change in price

This means that, along the demand curve between point B and A, if the price changes by 1%, the quantity demanded will change by xx%.

In our example, when the price rises from 20 to 25, quantity demand falls from 30000 to 27500.

% change in quantity demand = -8.33 and % change in price = 25

E = - 8.33/25 = -0.3333

Absolute value of e = 0.33

Since it is less than 1, the demand is inelastic.

This means that, along the demand curve between point B and A, if the price changes by 1%, the quantity demanded will change by 0.33%.

3.     Explain in your own words why MR = MC produces maximum profit for a company.

By definition, MR is the revenue gained by producing one extra unit of output and MC is the cost of producing one extra unit of output. Each firm wants to make positive profit.

MR = MC produces maximum profit for a company because up to this point, every unit produced has marginal revenue greater than marginal cost. After this point, MR starts declining and MC starts increasing which means the cost of producing each extra unit becomes burden to the firm and profit will turn negative (loss).

If a firm finds that MC>MR, it means the last extra unit produced has added more to the total cost and not in revenue. By reducing one unit of output, it can increase profit because it saves more costs.

Price $

Quantity = 40,000-500*P

elasticty e

TR $

TC $

Economic Profit $

10

     35,000

   350,000

   766,000

- 416,000

15

     32,500

-0.1429

   487,500

   716,000

- 228,500

20

     30,000

-0.2308

   600,000

   666,000

-    66,000

25

     27,500

-0.3333

   687,500

   616,000

     71,500

30

     25,000

-0.4545

   750,000

   566,000

   184,000

35

     22,500

-0.6000

   787,500

   516,000

   271,500

40

     20,000

-0.7778

   800,000

   466,000

   334,000

45

     17,500

-1.0000

   787,500

   416,000

   371,500

50

     15,000

-1.2857

   750,000

   366,000

   384,000

55

     12,500

-1.6667

   687,500

   316,000

   371,500

60

     10,000

-2.2000

   600,000

   266,000

   334,000

65

        7,500

-3.0000

487,500

   216,000

   271,500

70

        5,000

-4.3333

   350,000

   166,000

   184,000