Cost Theory and Estimation and Profit Maximization

1. The manager of the Electronic Corporation has estimated the total variable costs and total fixed cost
functions for producing a particular type of camera to be TVC = 60Q – 12Q 2 + Q3 and TFC = $100.

The corporation sells the cameras at the price of $60 each. An engineering study just published estimated that
if the corporation employs newly developed technology, the long-run total cost function would be
TC = 50 + 20Q + 2w + 3r where w = wage rate and r = rental price of capital. The manager asks you to find:

a) the average variable and marginal cost functions of the firm, the output level at which the two curves cross;

AVC = TVC = 60Q – 12Q2 + Q3 = 60 – 12Q + Q2

Q Q

TC = TVC + TFC = 60Q – 12Q2 + Q3 + 100

MC = dTC = d(60Q – 12Q2 + Q3 + 100) = 60 – 24Q + 3Q2

dQ dQ

AVC = MC when the two curves meet or intersect

60 – 12Q + Q = 60 – 24Q + 3Q2
2

0 = -12Q + 2Q2
2Q2 = 12Q
Q = 6

b) the breakeven output of the firm and the output at which the form maximizes its total profits;

TR = price x Q
= 60Q

TR = TC
60Q = 60Q – 12Q2 + Q3 + 100
0 = Q3 – 12Q2 + 100
Q ≈ 3.41 or Q = 3 cameras is the breakeven output

profit = TR – TC
profit = 60Q – 60Q + 12Q2 – Q3 – 100
dProfit = d(60Q – 60Q + 12Q2 – Q3 – 100)
dQ dQ

dProfit = 24Q – 3Q2

dQ

dProfit = 0 maxima/minima
dQ

24Q – 3Q2 = 0
Q (24 – 3Q) = 0
Q = 0 and Q = 8 where the firm maximizes total profit when output is 8 units(camera).
c) the long-run average cost and long-run marginal cost functions with the new technology if w=$20 and r=$10

TC = 50 + 20Q + 2w + 3r
= 50 + 20Q + 2(20) + 3(10)
= 20Q + 120

AC = TC/Q
AC = (20Q + 120) / Q average cost
MC = dTC/dQ
= d(20Q + 120)/dQ
MC = 20 marginal cost

d) should the corporation adopt the new technology? If it did, what would be the profit-maximizing level of
output if the firm can continue to sell its cameras at the price of $60 per unit?

The corporation should adopt the new technology since marginal cost is lower.

2. Determine the best level of output for a perfectly competitive firm that sells its product at P = $4 and faces
TC = 0.04Q3 – 0.9Q2 + 10Q + 5. Will the firm produce this level of output? Why?

TR = price x Q
= 4Q

Profit = TR – TC
Profit = 4Q – (0.04Q3 – 0.9Q2 + 10Q + 5)
= – 0.04Q3 + 0.9Q2 – 6Q – 5

dProfit = d(– 0.04Q3 + 0.9Q2 – 6Q – 5)

dQ dQ
= – 0.12Q2 + 1.8Q – 6 = 0 maxima/minima
(Q = 5) and (Q = 10)
Profit = – 0.04(5)3 + 0.9(5)2 – 6(5) – 5 for Q = 5
= – 17.5
= – 0.04(10)3 + 0.9(10)2 – 6(10) – 5 for Q = 10
= – 15

Selling the firm’s product at $4 per unit would result to negative profits. The firm should not produce this level
of output since it would be operating at a loss.

3. Given: Q = 120 – 10P and TC = 90 + 2Q for an oligopolistic firm, determine mathematically the:

a. output at which the firm maximizes its total profits and calculate P, TR, and total profit.
b. output at which the firm maximizes total revenue and calculate P, TR, and total profit.

Q = 120 – 10P
P = 120 – Q
10
= 12 – 0.1Q
TR = P x Q
= (12- 0.1Q) x (Q)
= 12Q – 0.1Q2

Profit = TR – TC
= 12Q – 0.1Q2 – 90 – 2Q
= – 90 + 10Q – 0.1Q2
dProfit = – 90 + 10Q – 0.1Q2
dQ dQ

= 10 – 0.2Q maxima/minima
Q = 50

P = 12 – 0.1(50)

P =7

TR = 7 (50)

TR = 350

Profit = 350 – (90 + 2(50))

Profit = 160