Module 1: Summary

Where we left off:

We have seen that, if we are able to estimate a demand curve, know our marginal costs
(or total costs), we can find the profit maximizing output level and price. This involves:
 Setting up the profit maximization problem properly
 Using basic calculus to solve the problem (find a Q such that MR = MC).

Objectives of these notes:

 To give you practice setting up and solving these basic profit maximization
problems
 To begin to dig more deeply into the demand side of our work.

Profit Maximization Practice Problems:

1. Suppose you have estimated your demand to be P = 50 – Q and your TC = 58+5Q

+.25Q2.

a. Does the cost function exhibit the properties of specialization and diminishing
returns? Explain fully.

If you draw this cost function out, you will see that TC increase at an increasing rate – the
property of diminishing returns. But, there is no specialization part – no part where TC
rise at a decreasing rate.

b. What is the profit maximizing output level? Explain all your work.

First, define profits: Profits = TR – TC

Profits = P*Q – (58 + 5Q + .25Q2)

Now, insert the demand constraint into the profit equation above (that is, sub in the
demand curve for P):

Profits = (50-Q)*Q - (58 + 5Q + .25Q2)

To solve, take the derivative of total profits to find marginal profits:

Marginal profits = dprofits/dQ = 50 – 2Q – 5 - .5Q.

Q* is where marginal profits are zero, so solve for Q by setting the equation just derived
equal to zero:
50 – 2Q - .5Q = 0: Q* = 20.

c. What is the profit maximizing price?

Now that we have solved for Q – how much output we should produce – we can now
determine the highest price we can charge and sell that amount:

Use the demand curve!: P = 50-Q: P* = 50 – 20: P* = 30.

Here are some important extensions:

 What is MR in this problem?

 How about MC?
 How large are profits in this case?
 If fixed costs change, PROVE that Q* and P* will not.
 Suppose demand increases, how would this affect Q* and P* - prove your answer
WITHOUT resolving!