Homework #2 – Part II – Profit Maximizing Level of Output
The following example builds on last week’s problem of computing average and marginal costs for a
firm. This week we are looking at the firm’s decision on how many tees to produce, its relationship to
costs and profits as price changes.
This problem looks at the firm’s profit maximizing output decision when the firm is in a perfectly
competitive market place. That is, the price of tees in the marketplace (where many other firms are also
supplying tees) is not affected by how many tees our firm produces. Instead, the market price for tees is
given … or “is what it is” and you don’t have any ability to affect it.
So our firm will look at the price (take the price as given, or as economists would say this firm is a “pricetaker”, rather than a “price-maker”), compare it against its costs and choose an output level that
maximizes profits. That is choose output such that the difference between total revenues and total
costs is greatest.
We’ll look at two scenarios here: (1) where the market price is $0.80 per tee and (2) where it is $1 per
tee.
1. Compute the Total Revenue and Profit for each level of output (1-10 tees) when the market
price is (a) $0.80 per tee and (b) $1.00 per tee
2. Find the profit maximizing level of output for both prices
3. What is the relationship between the market price and marginal cost at the profit maximizing
level of output (for both p = $1.00 and p =$0.80)
output
of tees
and
costs
Total
Marg
Avg Cost
TotRev@$0.80
Costs
Cost
1
$1.00
1
$1.00
Tees/day
2
$1.90
0.95
$0.90
3
$2.70
0.9
$0.80
4
$3.40
0.85
$0.70
5
$4.00
0.8
$0.60
6
$4.70 0.783333
$0.70
7
$5.50 0.785714
$0.80
8
$6.40
0.8
$0.90
9
$7.40 0.822222
$1.00
$8.60
$1.20
10
0.86
Profit@$0.80
TR @
$1
profit@$1