03.05 getting the most for your money

Marginal Cost and Revenue—Text Version

Slide 1:

Audio: Using marginal cost analysis, a business owner can determine the price and quantity that will maximize the firm's profits. On a graph, this is where marginal revenue and marginal cost intersect. Let's use an imaginary data chart for Air Jordans® to see why. Image: Title text states "Marginal Cost Analysis."

Slide 2

Audio: First, the person doing the analysis, perhaps a shoe store manager, constructs a data chart. Image: A table with seven columns labeled Quantity, Price (in whole dollars), Total Revenue, Marginal revenue, Total Cost, Marginal Cost and Profit or loss.

Slide 3:

Audio: In this type of chart, quantity represents the range of items a person wants to analyze. In our case, we are going to say the store manager wishes to analyze the marginal cost for a range of zero through eight pairs of Air Jordan® shoes. Image: Quantity column is populated down each row with the number 0-8.

Slide 4:

Audio: She determines the price she can charge for each quantity. So, let's say she can charge $105 for a single pair, but if someone buys eight pairs, she can bring the price down to $97 per pair. Notice that price is lower as quantity increases because people are willing to buy more shoes as their price goes down. Image: Price column is populated down each row with the price for each given quantity. ($105 for 0 pairs, $104 for 1 pair, $103 for 2 pairs, $102 for 3 pairs, $101 for 4 pairs, $100 for 5 pairs, $99 for 6 pairs, $98 for 7 pairs, and $97 for 8 pairs).

Slide 5:

Audio: She also determines how much it will cost to stock each quantity level. In other words, how much does it cost the store to sell a single pair versus six, seven, or eight pairs? Image: Total Cost column is highlighted on the table. ($60 for 0 pairs, $150 for 1 pair, $246 for 2 pairs, $291 for 3 pairs, $324 for 4 pairs, $369 for 5 pairs, $438 for 6 pairs, $555 for 7 pairs, and $681 for 8 pairs).

Slide 6:

Audio: With those three columns populated, she can move on to calculate the numbers in the Total Revenue column. Total Revenue is how much money the store makes for every pair they sell. Image: Total Revenue column is highlighted on the table.

Slide 7:

Audio: The store manager multiplies the quantity by the price in each row to determine the total revenue for each quantity. For example, at a quantity of one, she multiplies one by $104 to get a total of $104. She enters this in the Total Revenue column.

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Image: Highlighted cells on the table indicate the quantity (1) and the price ($104) with the resulting total revenue value of $104.

Slide 8:

Audio: Let's see it again. At a quantity of four, she multiplies the number four by price $101 to get a total revenue of $404, which she enters in the corresponding column. Image: Highlighted cells on the table indicate the quantity (4) and the price ($101) with the resulting total revenue value of $404. The total revenue column has also been populated at quantity (2) with a total revenue value of $206, and at quantity (3) with a total revenue value of $306.

Slide 9:

Audio: Now you try. Complete the remaining cells in this table by typing in the correct answer. Image: Last four cells in the Total Revenue column are blank and highlighted.

Check Your Answer

Answer

Quantity Price (in whole dollars) Total Revenue

5 100 500 6 99 594 7 98 686 8 97 776

Slide 10:

Audio: Good job! With this information, the manager can now calculate the Profit or Loss for each quantity. Image: Total Revenue column is populated for each quantity value.

Slide 11:

Audio: Still working across each row, the store manager now subtracts the total revenue minus the total cost, to determine profit or loss for each quantity of sneakers. For example, at a quantity of one, she subtracts a total revenue of $104 minus a total cost of $150. The result is -46, indicating that she will lose $46 if the store sells only one pair. Image: The highlighted cells on the table indicate the total revenue at a quantity of one ($104) and the total cost ($150) with the resulting Profit or Loss cell populated with the difference (-$46.) The Profit or Loss column has also been populated to reflect total revenue at a quantity of zero ($0) minus the total cost ($60) for a difference of (-$60).

Slide 12:

Audio: Let’s see it again. If the store sells seven pairs, the store earns $686 but paid out $555 to sell that many. $686 minus $555 equals a $131 profit, and we enter that dollar amount in the last column of the corresponding row. Image: The highlighted cells on the table indicate the total revenue at a quantity of seven ($686) and the total cost ($555) with the resulting Profit or Loss cell populated with the difference ($131.)

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Slide 13:

Audio: Now you try. Calculate the Profit or Loss for the remaining cells in this table and type in the correct answer. HINT: Total Revenue – Total Cost = Profit or Loss. Complete the remaining cells in this table by typing in the correct answer.

Image: The cells on the table indicate the total revenue at a quantity of six ($594) and the total cost ($438) with the resulting Profit or Loss cell populated with the difference ($156) and the total revenue at a quantity of eight ($776) and the total cost ($681) with the resulting Profit or Loss cell populated with the difference ($95). Remaining cells in the Profit or Loss column are empty and highlighted.

Check Your Answers

Answers

Quantity Total Revenue Total Cost Profit (or loss)

2 206 246 -40 3 306 291 15 4 404 324 80 5 500 369 131

Slide 14:

Audio: Great job! With these five columns filled out, the manager can now begin to calculate the last two columns of data!

Image: Profit or Loss column is populated for each quantity value.

Slide 15:

Audio: She'll continue with Marginal Revenue, in other words, the amount of money the store will gain for each additional pair of Air Jordans® sold. Image: Marginal Revenue column is highlighted.

Slide 16:

Audio: To calculate this, the store manager will use numbers from the Total Revenue column. Remember that the Total Revenue is the amount of money earned by the store for each pair sold.

Image:Total Revenue column is highlighted.

Slide 17:

Audio: Let's say we want to know how much money we can make if we sell two pairs instead of only one. According to the Total Revenue column, the store earns $104 for a single pair sold. If it sells two pairs it earns $206. Image: Total Revenue for one unit ($104) and two units ($206) are highlighted.

Slide 18:

Audio: 206 minus 104 equals 102. Now we know that $102 is the amount of money we can make if we sell two pairs instead of only one. $102 is the marginal revenue for two pairs sold.

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Image: Total Revenue for one unit ($104) and two units ($206) are highlighted as is the difference between them ($102), populating in the corresponding Marginal Revenue cell.

Slide 19:

Audio: Let's see it again. If we sell four pairs, our total revenue is $404. If we sell five pairs, our total revenue is $500. 500 minus 404 equals 96. That means that we make $96 more by selling that additional pair. $96 is the marginal revenue for five pairs sold.

Image: Total Revenue for four units ($404) and five units ($500) are highlighted as is the difference between them ($96), populating the corresponding Marginal Revenue cell. Marginal Revenue column has also been populated at quantity 0 ($0), quantity one ($104), quantity three ($100), and quantity four ($98).

Slide 20:

Audio: It's your turn! Calculate the Marginal Revenue for the highlighted cells and type in the correct answers. HINT: Total Revenue for X – Total Revenue for Y = Marginal Revenue. Complete the remaining cells in this table by typing in the correct answer.

Image: Remaining cells are highlighted and blank.

Check Your Answers

Answers

Quantity Total Revenue Marginal Revenue

6 594 94 7 686 92 8 776 90

Slide 21:

Audio: Excellent! We only have one column of data to go and our store manager will have a complete Marginal Cost Analysis! Marginal Revenue column is highlighted and populated for each quantity value.

Slide 22:

Audio: To calculate Marginal Cost, she will use the same process that she followed to complete the Marginal Revenue column. Image: Marginal Cost column is highlighted.

Slide 23:

Audio: Except this time, she is going to use the numbers in the Total Cost column. Remember that the Total Cost is the amount of money it costs the store to sell a single pair. But let's say we want to know how much money it will cost us to stock two pairs instead of only one. According to the Total Cost column, the store pays $150 for a single pair stocked. If it stocks two pairs it pays $246. Image: Total Cost column is highlighted.

Slide 24:

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Audio: 246 minus 150 equals 96. Now we know that $96 is the amount it costs us to stock two pairs instead of only one. $96 is the marginal cost to stock and keep two pairs on the shelf. Image: Total Cost for one unit ($150) and two units ($246) are highlighted as is the difference between them ($96), which populates the corresponding Marginal Cost cell. Marginal Cost column has also been populated at quantity one ($90).

Slide 25:

Audio: Let's see another example. According to the Total Cost column, the store's cost to sell four pairs is $324, while at three pairs the cost is $291. 324 minus 291 equals 33. $33 is the additional, or marginal cost, for the store to sell four pairs of Air Jordans® instead of three pairs. Image: Total cost for four units ($324) and three units ($291) are highlighted, as is the difference between them ($33) which populates the corresponding Marginal Cost cell. Marginal Cost column has also been populated at quantity three ($45).

Slide 26:

Audio: Now, you try! Complete the remaining cells in this table by typing in the correct answer. Image: Remaining cells in the Marginal Cost column are highlighted and empty.

Check Your Answers

Answers

Quantity Total Cost Marginal Cost

5 369 45

6 438 69

7 555 117

8 681 126

Slide 27:

Audio: Perfect! The store manager now has all of the data required for a complete Marginal Cost Analysis! Image: Marginal Cost column is populated for every quantity value.

Slide 28:

Audio: Now comes the fun part! Our store manager is a very visual person. She takes the data for marginal revenue and marginal cost, and creates a graph to compare these two sets of data. Price is along the y-axis and quantity along the x-axis. She first plots each data point for marginal revenue, then connects the points with a line. Then she does the same for marginal cost. Image: Graph shows price along the y-axis and quantity along the x-axis. The values from the Marginal Analysis table are plotted for Marginal Revenue and Marginal Cost. Marginal Revenue creates a downward sloping line, while Marginal Cost creates a J-curve.

Slide 29:

Audio: Examine the chart. How many pairs of Air Jordans should the store sell to maximize profit? Image: Graph shows price along the y-axis and quantity along the x-axis. The values from the Marginal Analysis table are plotted for Marginal Revenue and Marginal Cost. Marginal Revenue creates a

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downward sloping line, while Marginal Cost creates a J-curve. The lines intersect somewhere between the quantity values of six and seven.

Check Your Answer

Answer

Six pairs

Slide 30:

Audio: Six pairs is correct! Notice in the graph that six pairs is where marginal revenue is closest to equaling marginal cost without being lower than marginal cost. Though producers will seek to produce where marginal cost and marginal revenue are equal, it is not often exact. Exactness would require our salesperson to sell six and a portion pairs of Air Jordans®, perhaps the rubber sole and laces for a single shoe. Likely the salespeople will have difficulty with that sale, so six pairs will be fine. Image: Graph shows price along the y-axis and quantity along the x-axis. The values from the Marginal Analysis table are plotted for Marginal Revenue and Marginal Cost. Marginal Revenue creates a downward sloping line, while Marginal Cost creates a J-curve. The lines intersect somewhere between the quantity values of six and seven. An arrow is highlighting the point of intersection and indicating that six is the correct answer.

Slide 31:

Audio: Hopefully you have learned a bit more about Marginal Cost Analysis. As you continue through the lesson, you can always come back to this presentation to help you clarify these concepts or refresh your memory! Image: Text appears on the slide saying "Thank you for viewing."

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