Download Interactive Graph for Chapter 18—Marginal Analysis

NOTES ON THE INTERACTIVE EXERCISE
Overview of Interactive Exercise on Cost and Demand Concepts
The objective of this exercise is to show the relationship among several cost and demand
concepts. This exercise builds on the information that is presented in Chapter 18. The
step-by-step nature of the exercise allows students to work with a data table that is a
modification of Exhibit 18-9. By filling in the missing data in the table, the students
construct the curves representing demand, marginal revenue, marginal cost, and profit.
Concept Review:
Total fixed cost is the sum of those costs that are fixed in total--no matter how much is
produced.
Total variable cost is the sum of those changing expenses that are closely related to
output--such as expenses for parts, wages, packaging materials, outgoing freight, and
sales commissions.
Total cost is the sum of total fixed and total variable costs.
Marginal analysis is evaluating the change in total revenue and total cost from selling
one more unit to find the most profitable price and quantity.
Marginal revenue is the change in total revenue that results from the sale of one more
unit of a product.
Marginal cost is the change in total cost that results from producing one more unit.
The rule for maximizing profit is that the highest profit is earned at the price where
marginal cost is just less than or equal to marginal revenue.
Using the Exercise
Initial Screen
1. This screen contains a data table that has several missing pieces of information. The
instructor can move from left to right through the table asking students to supply the
information that will complete the table. Correct values change to green when
entered.
A. This “fill-in-the-blank” exercise presents the instructor with an opportunity to
make sure that students understand the basic relationships among the numbers in
the chart. Some examples of questions that might be asked include:
1) How does one compute total revenue? Answer: Total revenue is equal to the
quantity demanded multiplied by its corresponding price.
2) What are the components of total cost? Answer: Total cost is composed of
total fixed costs and total variable costs at a given quantity demanded.
3) At 0 units demanded, and $0 total revenue, why is there $200 in total cost?
Answer: The $200 reflects fixed costs. Each entry in the total cost column
reflects $200 worth of fixed costs, plus variable costs.
4) What are marginal revenue and marginal cost? Answer: Marginal cost is the
change in total revenue resulting from the sale of one additional unit of the
product. To compute it, take the total revenue at a given quantity sold, and
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subtract the total revenue that is generated if one less unit is produced/sold.
The same principle applies to marginal cost—the change in total cost
resulting from the sale of one additional unit of the product.
B. When ready, the instructor can click on the “Next” button to proceed to the next
screen.
Next Screen
2. This screen shows students the demand curve that results from the price-quantity
combinations in the data table; these values are reproduced in the table at the top of
the screen.
A. At this point, the instructor should ask the students, “What is the relationship
between price and quantity demanded that is shown in the graph?” Answer: The
demand curve slopes downward, so as the price decreases, the quantity demanded
increases. As the price increases, the quantity demanded decreases.
B. The instructor should then ask the class what would happen if greater price
reductions were required to effect changes in quantity demanded. Answer: This
would produce a second demand curve that will have a steeper slope than the first
one. Therefore, consumers would be less price sensitive. A flatter curve would
indicate that consumers were more price sensitive, because a smaller price
change would yield a greater change in quantity demanded.
C. When ready, the instructor can click on the “Next” button to proceed to the next
screen.
Next Screen
3. This screen brings in the marginal revenue and marginal cost curves.
A. Here, it is important to point out the point where marginal revenue and marginal
cost are equal, or in this case, almost equal (6 units produced/sold, marginal
revenue = $14, marginal cost = $13).
B. The price-quantity combination at this point (taken from the demand curve), is the
profit-maximizing point.
C. When ready, the instructor can click on the “Next” button to proceed to the next
screen.
Final Screen
4. This screen shows the highest point on the profit curve—the point where profits are
maximized—is where the profit is $106.
A. Summarizing the relationships among cost, revenue, and demand, marginal
revenue and marginal cost are equal at 6 units produced/sold at a cost of $79. (As
mentioned, technically speaking, they are not exactly equal at that point, as
marginal revenue is $14 and marginal cost is $13.)
B. The profit is at its maximum point of $106. In fact, the profit maximizing point is
always where marginal revenue is equal to (or slightly exceeds) marginal cost.
C. When ready, the instructor can click on the “Finish” button to end the exercise.
D. In closing, it is helpful to remind the students that as indicated in Chapter 17,
profit maximization is only one of several possible objectives for a pricing
strategy. Regardless of the pricing objective used, it is still important to know
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where the profit maximizing point is because it provides an important benchmark
for other possible objectives.
E. In addition, using marginal analysis to find the profit maximizing price and
quantity combination is a way to specifically take into account consumer demand
and costs in setting prices.
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