Applied Economics for Managers

Elasticity of Demand

We know from the law of demand how the quantity demanded will respond to a price change: it will change in the opposite direction. But how much will it change? It seems reasonable to expect, for example, that a 10 percent change in the price charged for a visit to the doctor would yield a different percentage change in quantity demanded than a 10 percent change in the price of a Ford Mustang. But how much is this difference?

To show how responsive quantity demanded is to a change in price, we apply the concept of elasticity. The price elasticity of demand for a good or service, eD, is the percentage change in quantity demanded of a particular good or service divided by the percentage change in the price of that good or service, all other things unchanged:
eD=%changeinquantitydemanded%changeinpriceeD=%changeinquantitydemanded%changeinprice
Because the price elasticity of demand shows the responsiveness of quantity demanded to a price change, assuming that other factors that influence demand are unchanged, it reflects movements along a demand curve. With a downward-sloping demand curve, price and quantity demanded move in opposite directions, so the price elasticity of demand is always negative. A positive percentage change in price implies a negative percentage change in quantity demanded, and vice versa. Sometimes you will see the absolute value of the price elasticity measure reported. In essence, the minus sign is ignored because it is expected that there will be a negative (inverse) relationship between quantity demanded and price. In this text, however, we will retain the minus sign in reporting price elasticity of demand and will say “the absolute value of the price elasticity of demand” when that is what we are describing.
Computing the Price Elasticity of Demand
Finding the price elasticity of demand requires that we first compute percentage changes in price and in quantity demanded. We calculate those changes between two points on a demand curve.
The figure below, Responsiveness and Demand, shows a particular demand curve, a linear demand curve for public transit rides. Suppose the initial price is $0.80, and the quantity demanded is 40,000 rides per day; we are at point A on the curve. Now suppose the price falls to $0.70, and we want to report the responsiveness of the quantity demanded. We see that at the new price, the quantity demanded rises to 60,000 rides per day (point B). To compute the elasticity, we need to compute the percentage changes in price and in quantity demanded between points A and B.

Responsiveness and Demand

The demand curve shows how changes in price lead to changes in the quantity demanded. A movement from point A to point B shows that a $0.10 reduction in price increases the number of rides per day by 20,000. A movement from B to A is a $0.10 increase in price, which reduces quantity demanded by 20,000 rides per day.
We measure the percentage change between two points as the change in the variable divided by the average value of the variable between the two points. Thus, the percentage change in quantity between points A and B is computed relative to the average of the quantity values at points A and B: (60,000 + 40,000)/2 = 50,000. The percentage change in quantity, then, is 20,000/50,000, or 40 percent. Likewise, the percentage change in price between points A and B is based on the average of the two prices: ($0.80 + $0.70)/2 = $0.75, and so we have a percentage change of −0.10/0.75, or −13.33 percent. The price elasticity of demand between points A and B is thus 40 percent/(−13.33%) = −3.00.
This measure of elasticity, which is based on percentage changes relative to the average value of each variable between two points, is called arc elasticity. The arc elasticity method has the advantage that it yields the same elasticity whether we go from point A to point B or from point B to point A. It is the method we shall use to compute elasticity.
For the arc elasticity method, we calculate the price elasticity of demand using the average value of price, P¯¯¯¯P¯, and the average value of quantity demanded, Q¯¯¯¯Q¯. We shall use the Greek letter Δ to mean change in, so the change in quantity between two points is ΔQ and the change in price is ΔP. Now we can write the formula for the price elasticity of demand as
eD=ΔQ/Q¯¯¯¯ΔP/P¯¯¯¯eD=ΔQ/Q¯ΔP/P¯
The price elasticity of demand between points A and B is thus:
eD=20,000(40,000+60,000)/2−$0.10($0.80+$0.70)/2=40%−13.33%=−3.00eD=20,000(40,000+60,000)/2−$0.10($0.80+$0.70)/2=40%−13.33%=−3.00
With the arc elasticity formula, the elasticity is the same whether we move from point A to point B or from point B to point A. If we start at point B and move to point A, we have:
eD=−20,000(60,000+40,000)/2$0.10($0.80+$0.70)/2=−40%13.33%=−3.00eD=−20,000(60,000+40,000)/2$0.10($0.80+$0.70)/2=−40%13.33%=−3.00
The arc elasticity method gives us an estimate of elasticity. It gives the value of elasticity at the midpoint over a range of change, such as the movement between points A and B. For a precise computation of elasticity, we would need to consider the response of a dependent variable to an extremely small change in an independent variable. The fact that arc elasticities are approximate suggests an important practical rule in calculating arc elasticities: we should consider only small changes in independent variables. We cannot apply the concept of arc elasticity to large changes.
Another argument for considering only small changes in computing price elasticities of demand will become evident in the next section. We will investigate what happens to price elasticities as we move from one point to another along a linear demand curve.
Elastic, Unit Elastic, and Inelastic Demand
To determine how a price change will affect total revenue, economists place price elasticities of demand in three categories, based on their absolute value. If the absolute value of the price elasticity of demand is greater than 1, demand is termed price elastic. If it is equal to 1, demand is unit price elastic. And if it is less than 1, demand is price inelastic.

Elastic and Inelastic Price

Determinants of the Price Elasticity of Demand
The greater the absolute value of the price elasticity of demand, the greater the responsiveness of quantity demanded to a price change. What determines whether demand is more or less price elastic? The most important determinants of the price elasticity of demand for a good or service are the availability of substitutes, the importance of the item in household budgets, and time.

Elasticity of Supply

The elasticity of supply (eS) measures the responsiveness of the quantity supplied to a change in the price. The subscript S denotes supply. You might notice that this is exactly the same formula as for the demand curve, except that the quantities now come from a supply curve.
es=percentagechangeinquantitysuppliedpercentagechangeinprice=changeDQchangeDPes=percentagechangeinquantitysuppliedpercentagechangeinprice=changeDQchangeDP
 
Furthermore, and in contrast to demand elasticity, the supply elasticity is generally a positive value because of the positive relationship between price and quantity supplied. The more elastic, or the more responsive, supply is to a given price change, the larger the elasticity value will be. This means that flatter supply curves have a greater elasticity than more vertical curves at a given price and quantity combination. Numerically, the flatter curve has a larger value than the more vertical supply. Technically, a completely vertical supply curve has zero elasticity and a horizontal supply curve has infinite elasticity.

Fixed, Variable, and Marginal Costs

Total cost is combination of fixed costs and variable costs. We will cover those concepts first, before discussing marginal cost (MC).
Fixed and Variable Costs

Fixed costs are expenditures that do not change regardless of the level of production, at least not in the short term. Whether you produce a lot or a little, the fixed costs are the same. One example is the rent on a factory or a retail space. Once you sign the lease, the rent is the same regardless of how much you produce, at least until the lease runs out. Fixed costs can take many other forms: the cost of machinery or equipment to produce the product, research and development costs to develop new products, even an expense like advertising to popularize a brand name. The level of fixed costs varies according to the specific line of business: for instance, manufacturing computer chips requires an expensive factory, but a local moving and hauling business can get by with almost no fixed costs at all if it rents trucks by the day when needed.

Variable costs, on the other hand, are incurred in the act of producing—the more you produce, the greater the variable cost. Labor is treated as a variable cost, since producing a greater quantity of a good or service typically requires more workers or more work hours. Variable costs would also include raw materials.
As a concrete example of fixed and variable costs, consider the barber shop called The Clip Joint shown in the figure below. The data for output and costs are shown in the table that follows. The fixed costs of operating the barber shop, including the space and equipment, are $160 per day. The variable costs are the costs of hiring barbers, which in our example is $80 per barber each day. The first two columns of the table show the quantity of haircuts the barbershop can produce as it hires additional barbers. The third column shows the fixed costs, which do not change regardless of the level of production. The fourth column shows the variable costs at each level of output. These are calculated by taking the amount of labor hired and multiplying by the wage. For example, two barbers cost $2 × $80 = $160. Adding together the fixed costs in the third column and the variable costs in the fourth column produces the total costs in the fifth column. So, for example, with two barbers the total cost is $160 + $160 = $320.

How Output Affects Total Costs

At zero production, the fixed costs of $160 are still present. As production increases, variable costs are added to fixed costs, and the total cost is the sum of the two.

Output and Total Costs

Labor

Quantity

Fixed cost

Variable cost

Total cost

1

16

$160

$80

$240

2

40

$160

$160

$320

3

60

$160

$240

$400

4

72

$160

$320

$480

5

80

$160

$400

$560

6

84

$160

$480

$640

7

82

$160

$560

$720

 
The relationship between the quantity of output being produced and the cost of producing that output is shown graphically in the figure. The fixed costs are always shown as the vertical intercept of the total cost curve; that is, they are the costs incurred when output is zero, so there are no variable costs.
You can see from the graph that once production starts, total costs and variable costs rise. While variable costs may initially increase at a decreasing rate, at some point they begin increasing at an increasing rate. This is caused by diminishing marginal returns, which is easiest to see with an example. As the number of barbers increases from zero to one in the table, output increases from 0 to 16 for a marginal gain of 16; as the number rises from one to two barbers, output increases from 16 to 40, a marginal gain of 24. From that point on, though, the marginal gain in output diminishes as each additional barber is added. For example, as the number of barbers rises from two to three, the marginal output gain is only 20; and as the number rises from three to four, the marginal gain is only 12.
To understand the reason behind this pattern, consider that a one-man barber shop is a very busy operation. The single barber needs to do everything: say hello to people entering, answer the phone, cut hair, sweep up, and run the cash register. A second barber reduces the level of disruption from jumping back and forth between these tasks, and allows a greater division of labor and specialization. The result can be greater increasing marginal returns. However, as other barbers are added, the advantage of each additional barber is less, since the specialization of labor can only go so far. The addition of a sixth or seventh or eighth barber just to greet people at the door will have less impact than the second one did. This is the pattern of diminishing marginal returns. As a result, the total costs of production will begin to rise more rapidly as output increases. At some point, you may even see negative returns as the additional barbers begin bumping elbows and getting in each other’s way. In this case, the addition of still more barbers would actually cause output to decrease, as shown in the last row of the table above.
This pattern of diminishing marginal returns is common in production. As another example, consider the problem of irrigating a crop on a farmer’s field. The plot of land is the fixed factor of production, while the water that can be added to the land is the key variable cost. As the farmer adds water to the land, output increases. But adding more and more water brings smaller and smaller increases in output, until at some point the water floods the field and actually reduces output. Diminishing marginal returns occur because, at a given level of fixed costs, each additional input contributes less and less to overall production.
Average Total Cost, Average Variable Cost, Marginal Cost
The breakdown of total costs into fixed and variable costs can provide a basis for other insights as well. The first five columns of the next table duplicate the previous table, but the last three columns show average total cost (ATC), average variable costs, and marginal costs. These new measures analyze costs on a per-unit (rather than a total) basis and are reflected in the curves shown in the figure below.

Different Types of Costs

Labor

Quantity

Fixed cost

Variable cost

Total cost

Marginal cost

Average total cost

Average variable cost

1

16

$160

$80

$240

$5.00

$15.00

$5.00

2

40

$160

$160

$320

$3.30

$8.00

$4.00

3

60

$160

$240

$400

$4.00

$6.60

$4.00

4

72

$160

$320

$480

$6.60

$6.60

$4.40

5

80

$160

$400

$560

$10.00

$7.00

$5.00

6

84

$160

$480

$640

$20.00

$7.60

$5.70

Cost Curves at the Clip Joint

The information on total costs, fixed cost, and variable cost can also be presented on a per-unit basis. Average total cost (ATC) is calculated by dividing total cost by the total quantity produced. The average total cost curve is typically U-shaped. Average variable cost (AVC) is calculated by dividing variable cost by the quantity produced. The average variable cost curve lies below the average total cost curve and is typically U-shaped or upward-sloping. Marginal cost (MC) is calculated by taking the change in total cost between two levels of output and dividing by the change in output. The marginal cost curve is upward-sloping.

Average total cost (sometimes referred to simply as average cost) is total cost divided by the quantity of output. Since the total cost of producing 40 haircuts is $320, the average total cost for producing each of 40 haircuts is $320/40, or $8 per haircut. Average cost curves are typically U-shaped, as the figure above shows. Average total cost starts off relatively high, because at low levels of output total costs are dominated by the fixed cost; mathematically, the denominator is so small that average total cost is large. Average total cost then declines, as the fixed costs are spread over an increasing quantity of output. In the average cost calculation, the rise in the numerator of total costs is relatively small compared to the rise in the denominator of quantity produced. But as output expands still further, the average cost begins to rise. At the right side of the average cost curve, total costs begin rising more rapidly as diminishing returns kick in.

Average variable cost is obtained when variable cost is divided by quantity of output. For example, the variable cost of producing 80 haircuts is $400, so the average variable cost is $400/80, or $5 per haircut. Note that at any level of output, the average variable cost curve will always lie below the curve for average total cost, as shown in the figure above. The reason is that average total cost includes average variable cost and average fixed cost. Thus, for Q = 80 haircuts, the average total cost is $8 per haircut, while the average variable cost is $5 per haircut. However, as output grows, fixed costs become relatively less important (since they do not rise with output), so average variable cost sneaks closer to average cost.
Average total and variable costs measure the average costs of producing some quantity of output. Marginal cost is somewhat different. Marginal cost is the additional cost of producing one more unit of output. So it is not the cost per unit of all units being produced, but only the next one (or next few). Marginal cost can be calculated by taking the change in total cost and dividing it by the change in quantity. For example, as quantity produced increases from 40 to 60 haircuts, total costs rise by 400 – 320, or 80. Thus, the marginal cost for each of those marginal 20 units will be 80/20, or $4 per haircut. The marginal cost curve is generally upward-sloping, because diminishing marginal returns implies that additional units are more costly to produce. A small range of increasing marginal returns can be seen in the figure as a dip in the marginal cost curve before it starts rising. There is a point at which marginal and average costs meet.
Where Do Marginal and Average Costs Meet?
The marginal cost line intersects the average cost line exactly at the bottom of the average cost curve—which occurs at a quantity of 72 and cost of $6.60 in the figure above. The reason the intersection occurs at this point is built into the economic meaning of marginal and average costs. If the marginal cost of production is below the average cost for producing previous units, as it is for the points to the left of where MC crosses ATC, then producing one more additional unit will reduce average costs overall—and the ATC curve will be downward-sloping in this zone. Conversely, if the marginal cost of production for producing an additional unit is above the average cost for producing the earlier units, as it is for points to the right of where MC crosses ATC, then producing a marginal unit will increase average costs overall—and the ATC curve must be upward-sloping in this zone. The point of transition, between where MC is pulling ATC down and where it is pulling it up, must occur at the minimum point of the ATC curve.
This idea of the marginal cost “pulling down” the average cost or “pulling up” the average cost may sound abstract, but think about it in terms of your own grades. If the score on the most recent quiz you take is lower than your average score on previous quizzes, then the marginal quiz pulls down your average. If your score on the most recent quiz is higher than the average on previous quizzes, the marginal quiz pulls up your average. In this same way, low marginal costs of production first pull down average costs and then higher marginal costs pull them up.
The numerical calculations behind average cost, average variable cost, and marginal cost will change from firm to firm. However, the general patterns of these curves, and the relationships and economic intuition behind them, will not change.
Lessons from Alternative Measures of Costs
Breaking down total costs into fixed cost, marginal cost, average total cost, and average variable cost is useful because each statistic offers its own insights for the firm.
Whatever the firm’s quantity of production, total revenue must exceed total costs if it is to earn a profit. Fixed costs are often sunk costs that cannot be recouped. In thinking about what to do next, sunk costs should typically be ignored, since this spending has already been made and cannot be changed. However, variable costs can be changed, so they convey information about the firm’s ability to cut costs in the present and the extent to which costs will increase if production rises.
Average cost tells a firm whether it can earn profits given the current price in the market. If we divide profit by the quantity of output produced we get average profit, also known as the firm’s profit margin. Expanding the equation for profit yields:
averageprofit=profitquantityproduced=totalrevenue−totalcostquantityproduced=totalrevenuequantityproduced−totalcostquantityproduced=averagerevenue−averagecostaverageprofit=profitquantityproduced=totalrevenue−totalcos⁡tquantityproduced=totalrevenuequantityproduced−totalcos⁡tquantityproduced=averagerevenue−averagecos⁡t
But note that:
averagerevenue=price×quantityproducedquantityproduced=priceaveragerevenue=price×quantityproducedquantityproduced=price

Thus:
averageprofit=price−averagecostaverageprofit=price−averagecos⁡t
 
This is the firm’s profit margin. This definition implies that if the market price is above average cost, average profit, and thus total profit, will be positive; if price is below average cost, then profits will be negative.
The marginal cost of producing an additional unit can be compared with the marginal revenue gained by selling that additional unit to reveal whether the additional unit is adding to total profit. Thus, marginal cost helps producers understand how profits would be affected by increasing or decreasing production.
 

Check Your Knowledge

The WipeOut Ski Company is preparing for the 2016 winter production season by evaluating the manufacturing costs of skis. Fixed costs are currently $30 and the company needs to know total cost, average variable cost, average total cost, and marginal cost.

WipeOut Ski Company

Quantity

Variable

cost

Fixed

cost

Total

cost

Average

total cost

Average

variable cost

Marginal

cost

0

0

$30

 

 

 

 

1

$10

$30

 

 

 

 

2

$25

$30

 

 

 

 

3

$45

$30

 

 

 

 

4

$70

$30

 

 

 

 

5

$100

$30

 

 

 

 

6

$135

$30

 

 

 

 

Question 1
What is the total cost if the variable cost is $45?

$15

$45

$70

$75
Question 2
What is the average total cost for a quantity of 4?

$12.50

$15.00

$20.00

$25.00
Question 3
What is the average variable cost if the total cost is $130?

$20.00

$22.50

$25.00

$27.50
Question 4
What is the marginal cost if the quantity is 3?

$10

$15

$20

$25
Solution
Complete solution for WipeOut Ski Company example
 

Quantity

Variable Cost

Fixed Cost

Total Cost

Average Total Cost

Average Variable Cost

Marginal Cost

0

0

$30

$30

–

–

 

1

$10

$30

$40

$10.00

$40.00

$10

2

$25

$30

$55

$12.50

$27.50

$15

3

$45

$30

$75

$15.00

$25.00

$20

4

$70

$30

$100

$17.50

$25.00

$25

5

$100

$30

$130

$20.00

$26.00

$30

6

$135

$30

$165

$22.50

$27.50

$35

 
Answer the following questions based on the complete solution to the WipeOut Ski Company example. Imagine a situation where the firm produces a quantity of five units that it sells for a price of $25 each.
Question 5
What will be the company’s profits or losses?

loss of $5

loss of $1

profit of $1

profit of $4
Question 6
How can you tell at a glance whether the company is making or losing money at this price? What could you compare the price to?

total cost

average total cost

average variable cost

marginal cost
Question 7
At the given quantity and price, is the marginal unit produced adding to profits?

Yes

Breaking even

No

Resources

Example of Marginal Cost Determined Through Analysis: A Night on the Town

Total Revenue and Marginal Revenue

The increase in total revenue from a one-unit increase in quantity is marginal revenue. Thus marginal revenue (MR) equals the slope of the total revenue curve. Each total revenue curve is a linear, upward-sloping curve. At any price, the greater the quantity a perfectly competitive firm sells, the greater its total revenue. Notice that the greater the price, the steeper the total revenue curve is. A firm’s total revenue is found by multiplying its output by the price at which it sells that output. For a perfectly competitive firm, total revenue (TR) is the market price (P) times the quantity the firm produces (Q), or TR = P × Q. 
Marginal revenue equals the market price. Because the market price is not affected by the output choice of a single firm, the marginal revenue the firm gains by producing one more unit is always the market price. The marginal revenue curve shows the relationship between marginal revenue and the quantity a firm produces. In perfect competition, a firm’s marginal revenue curve is a horizontal line at the market price.
The average and marginal revenue curves are given by the same horizontal line. When the marginal value exceeds the average value, the average value will be rising. When the marginal value is less than the average value, the average value will be falling.
We have seen that a perfectly competitive firm’s marginal revenue curve is simply a horizontal line at the market price and that this same line is also the firm’s average revenue curve. For the perfectly competitive firm, MR = P = AR. The marginal revenue curve has another meaning as well. It is the demand curve facing a perfectly competitive firm.
Price, Marginal Revenue, and Average Revenue
The slope of a total revenue curve is particularly important. It equals the change in the vertical axis (total revenue) divided by the change in the horizontal axis (quantity) between any two points. The slope measures the rate at which total revenue increases as output increases. We can think of it as the increase in total revenue associated with a one-unit increase in output. The increase in total revenue from a one-unit increase in quantity is marginal revenue. Thus marginal revenue (MR) equals the slope of the total revenue curve.
How much additional revenue does a radish producer gain from selling one more pound of radishes? The answer, of course, is the market price for one pound. Marginal revenue equals the market price. Because the market price is not affected by the output choice of a single firm, the marginal revenue the firm gains by producing one more unit is always the market price. The marginal revenue curve shows the relationship between marginal revenue and the quantity a firm produces. For a perfectly competitive firm, the marginal revenue curve is a horizontal line at the market price. If the market price of a pound of radishes is $0.40, then the marginal revenue is $0.40. In perfect competition, a firm’s marginal revenue curve is a horizontal line at the market price.
Price also equals average revenue, which is total revenue divided by quantity. To obtain average revenue (AR), we divide total revenue by quantity (Q). Because total revenue equals price (P) times quantity (Q), dividing by quantity leaves us with price.
AR=TRQ=P×QQ=PAR=TRQ=P×QQ=P

The marginal revenue curve is a horizontal line at the market price, and average revenue equals the market price. The average and marginal revenue curves are given by the same horizontal line. This is consistent with what we have learned about the relationship between marginal and average values. When the marginal value exceeds the average value, the average value will be rising. When the marginal value is less than the average value, the average value will be falling. What happens when the average and marginal values do not change, as in the horizontal curves of Panel (b) of the figure below, titled Total Revenue, Marginal Revenue, and Average Revenue? The marginal value must equal the average value; the two curves coincide.
Marginal Revenue, Price, and Demand for the Perfectly Competitive Firm
We have seen that a perfectly competitive firm’s marginal revenue curve is simply a horizontal line at the market price and that this same line is also the firm’s average revenue curve. For the perfectly competitive firm, MR = P = AR. The marginal revenue curve has another meaning as well. It is the demand curve facing a perfectly competitive firm.
Consider the case of a single radish producer, Tony Gortari. We assume that the radish market is perfectly competitive and that Mr. Gortari runs a perfectly competitive firm. Suppose the market price of radishes is $0.40 per pound. How many pounds of radishes can Mr. Gortari sell at this price? The answer comes from our assumption that he is a price taker: he can sell any quantity he wishes at this price. How many pounds of radishes will he sell if he charges a price that exceeds the market price? None. His radishes are identical to those of every other firm in the market, and everyone in the market has complete information. That means the demand curve facing Mr. Gortari is a horizontal line at the market price as illustrated in the following figure Price, Marginal Revenue, and Demand. The horizontal line is also Mr. Gortari’s marginal revenue curve, his average revenue curve, and the price market.
Of course, Mr. Gortari could charge a price below the market price, but why would he? We assume he can sell all the radishes he wants at the market price; there would be no reason to charge a lower price. Mr. Gortari faces a demand curve that is a horizontal line at the market price. In our subsequent analysis, we shall refer to the horizontal line at the market price simply as marginal revenue. We should remember, however, that this same line gives us the market price, average revenue, and the demand curve facing the firm.

Price, Marginal Revenue, and Demand

A perfectly competitive firm faces a horizontal demand curve at the market price. Here, radish grower Tony Gortari faces demand curve d at the market price of $0.40 per pound. He could sell q1 or q2—or any other quantity per month—at a price of $0.40 per pound.
More generally, we can say that any perfectly competitive firm faces a horizontal demand curve at the market price. We saw an example of a horizontal demand curve in the chapter on elasticity. Such a curve is perfectly elastic, meaning that any quantity is demanded at a given price.
Economic Profit in the Short Run
A firm’s economic profit is the difference between total revenue and total cost. Recall that total cost is the opportunity cost of producing a certain good or service. When we speak of economic profit we are speaking of a firm’s total revenue excluding the total opportunity cost of its operations.
A firm’s total cost curve in the short run intersects the vertical axis at some positive value equal to the firm’s total fixed costs. Total cost then rises at a decreasing rate over the range of increasing marginal returns to the firm’s variable factors. It rises at an increasing rate over the range of diminishing marginal returns. The next figure, Total Revenue, Total Cost, and Economic Profit, shows the total cost curve for Mr. Gortari, as well as the total revenue curve for a price of $0.40 per pound. Suppose that his total fixed cost is $400 per month. For any given level of output, Mr. Gortari’s economic profit is the vertical distance between the total revenue curve and the total cost curve at that level.

Total Revenue, Total Cost, and Economic Profit

Economic profit is the vertical distance between the total revenue and total cost curves (revenue minus costs). Here, the maximum profit attainable by Tony Gortari for his radish production is $938 per month at an output of 6,700 pounds.
Let us examine the total revenue and total cost curves in the above figure. At zero units of output, Mr. Gortari’s total cost is $400 (his total fixed cost); total revenue is zero. Total cost continues to exceed total revenue up to an output of 1,500 pounds per month, at which point the two curves intersect. At this point, economic profit equals zero. As Mr. Gortari expands output above 1,500 pounds per month, total revenue becomes greater than total cost. We see that at a quantity of 1,500 pounds per month, the total revenue curve is steeper than the total cost curve. Because revenues are rising faster than costs, profits rise with increased output. As long as the total revenue curve is steeper than the total cost curve, profit increases as the firm increases its output.
The total revenue curve’s slope does not change as the firm increases its output. But the total cost curve becomes steeper and steeper as diminishing marginal returns set in. Eventually, the total cost and total revenue curves will have the same slope. In our example, that happens at an output of 6,700 pounds of radishes per month. Notice that a line drawn tangent to the total cost curve at that quantity has the same slope as the total revenue curve.
As output increases beyond 6,700 pounds, the total cost curve continues to become steeper. It becomes steeper than the total revenue curve, and profits fall as costs rise faster than revenues. At an output slightly above 8,000 pounds per month, the total revenue and cost curves intersect again, and economic profit equals zero. Mr. Gortari achieves the greatest profit possible by producing 6,700 pounds of radishes per month, the quantity at which the total cost and total revenue curves have the same slope. More generally, we can conclude that a perfectly competitive firm maximizes economic profit at the output level at which the total revenue curve and the total cost curve have the same slope.

Applying the Marginal Decision Rule

The slope of the total revenue curve is marginal revenue; the slope of the total cost curve is marginal cost. Economic profit, the difference between total revenue and total cost, is maximized where marginal revenue equals marginal cost. This is consistent with the marginal decision rule, which holds that a profit-maximizing firm should increase output until the marginal benefit of an additional unit equals the marginal cost. The marginal benefit of selling an additional unit is measured as marginal revenue. Finding the output at which marginal revenue equals marginal cost is thus an application of our marginal decision rule.
The figure below, titled Applying the Marginal Decision Rule, shows how a firm can use the marginal decision rule to determine its profit-maximizing output. Panel (a) shows the market for radishes; the market demand curve (D), and supply curve (S); and a market price of $0.40 per pound. In Panel (b), the MR curve is given by a horizontal line at the market price. The firm’s marginal cost curve (MC) intersects the marginal revenue curve at the point where profit is maximized. Mr. Gortari maximizes profits by producing 6,700 pounds of radishes per month. That is, of course, the result we obtained in the figure above, where we saw that the firm’s total revenue and total cost curves differ by the greatest amount at the point at which the slopes of the curves, which equal marginal revenue and marginal cost, respectively, are equal.

Applying the Marginal Decision Rule

The market price is determined by the intersection of demand and supply. As always, the firm maximizes profit by applying the marginal decision rule. It takes the market price, $0.40 per pound, as given and selects an output at which MR equals MC. Economic profit per unit is the difference between average total cost (ATC) and price (here, $0.14 per pound); economic profit is profit per unit times the quantity produced ($0.14 × 6,700 = $938).
Demand and Marginal Revenue
Again, in the perfectly competitive case, the additional revenue a firm gains from selling an additional unit—its marginal revenue—is equal to the market price. The firm’s demand curve, which is a horizontal line at the market price, is also its marginal revenue curve. But a monopoly firm can sell an additional unit only by lowering the price. That fact complicates the relationship between the monopoly’s demand curve and its marginal revenue.
Suppose the firm in the following figure sells two units at a price of $8 per unit. Its total revenue is $16. Now it wants to sell a third unit and wants to know the marginal revenue of that unit. To sell three units rather than two, the firm must lower its price to $7 per unit. Total revenue rises to $21. The marginal revenue of the third unit is thus $5. But the price at which the firm sells three units is $7. Marginal revenue is less than price.

Data for Demand, Elasticity, and Total Revenue

Price in $

10 

9 

8

7

6

5

4

3

2

1

0

Quantity

0

1

2

3

4

5

6

7

8

9

10 

Total revenue in $

0

9

16 

21 

24 

25 

24 

21 

16 

9 

0

Demand Elasticity and Total Revenue

Suppose a monopolist faces the downward-sloping demand curve shown in Panel (a). In order to increase the quantity sold, it must cut the price. Total revenue is found by multiplying the price and quantity sold at each price. Total revenue, plotted in Panel (b), is maximized at $25, when the quantity sold is five units and the price is $5. At that point on the demand curve, the price elasticity of demand equals −1.
To see why the marginal revenue of the third unit is less than its price, we need to examine more carefully how the sale of that unit affects the firm’s revenues. The firm brings in $7 from the sale of the third unit. But selling the third unit required the firm to charge a price of $7 instead of the $8 the firm was charging for two units. Now the firm receives less for the first two units. The marginal revenue of the third unit is the $7 the firm receives for that unit minus the $1 reduction in revenue for each of the first two units. The marginal revenue of the third unit is thus $5. (In this chapter we assume that the monopoly firm sells all units of output at the same price. In the next chapter, we will look at cases in which firms charge different prices to different customers.)
Marginal revenue is less than price for the monopoly firm. The following figure shows the relationship between demand and marginal revenue, based on the demand curve introduced in the figure above, Demand, Elasticity, and Total Revenue. As always, we follow the convention of plotting marginal values at the midpoints of the intervals. For instance, the marginal revenue for the first unit is $9, and so is graphed in the interval between 0 and 1 units.

Data for Demand and Marginal Revenue

Price in $

10 

9  

8

7

6

5

4

3

2

1

0

Quantity

0

1

2

3

4

5

6

7

8

9

10 

Total Revenue in $

0

9

16 

21 

24 

25 

24 

21

16

9

0

Marginal Revenue $

_

9

7

5

3

1

-1

-3 

-5 

-7 

-9

The marginal revenue curve for the monopoly firm lies below its demand curve. It shows the additional revenue gained from selling an additional unit. Notice that, as always, marginal values are plotted at the midpoints of the respective intervals.
When the demand curve is linear, the marginal revenue curve can be placed according to the following rules: the marginal revenue curve is always below the demand curve and the marginal revenue curve will bisect any horizontal line drawn between the vertical axis and the demand curve. To put it another way, the marginal revenue curve will be twice as steep as the demand curve. The demand curve in the figure above is given by the equation Q = 10 − P, which can be written P = 10 − Q. The marginal revenue curve is given by P = 10 − 2Q, which is twice as steep as the demand curve.
The marginal revenue and demand curves in the figure above follow these rules. The marginal revenue curve lies below the demand curve and bisects any horizontal line drawn from the vertical axis to the demand curve. At a price of $6, for example, the quantity demanded is four. The marginal revenue curve passes through two units at this price. At a price of zero, the quantity demanded is 10; the marginal revenue curve passes through five units at this point.
Just as there is a relationship between the firm’s demand curve and the price elasticity of demand, there is a relationship between its marginal revenue curve and elasticity. Where marginal revenue is positive, demand is price elastic. Where marginal revenue is negative, demand is price inelastic. Where marginal revenue is zero, demand is unit-price elastic.

Relationship between Marginal Revenue and Demand

When marginal revenue is …

then demand is …

positive

price elastic

negative

price inelastic

zero

unit price elastic

A firm would not produce an additional unit of output with negative marginal revenue. And, assuming that the production of an additional unit has some cost, a firm would not produce the extra unit if it has zero marginal revenue. Because a monopoly firm will generally operate where marginal revenue is positive, we see once again that it will operate in the elastic range of its demand curve.
Monopoly Equilibrium: Applying the Marginal Decision Rule
Profit-maximizing behavior is always based on the marginal decision rule: additional units of a good should be produced as long as the marginal revenue of an additional unit exceeds the marginal cost. The maximizing solution occurs where marginal revenue equals marginal cost. As always, firms seek to maximize economic profit, and costs are measured in the economic sense of opportunity cost.
The next figure, The Monopoly Solution, shows a demand curve and an associated marginal revenue curve facing a monopoly firm. The marginal cost curve is like those we derived earlier; it falls over the range of output in which the firm experiences increasing marginal returns, then rises as the firm experiences diminishing marginal returns.

The Monopoly Solution

The monopoly firm maximizes profit by producing an output Qm at point G, where the marginal revenue and marginal cost curves intersect. It sells this output at price Pm.
To determine the profit-maximizing output, we note the quantity at which the firm’s marginal revenue and marginal cost curves intersect (Qm in The Monopoly Solution above). We read up from Qm to the demand curve to find the price Pm at which the firm can sell Qm units per period. The profit-maximizing price and output are given by point E on the demand curve.
Thus we can determine a monopoly firm’s profit-maximizing price and output by following three steps:
1. Determine the demand, marginal revenue, and marginal cost curves.
2. Select the output level at which the marginal revenue and marginal cost curves intersect.
3. Determine from the demand curve the price at which that output can be sold.

Computing Monopoly Profit

A monopoly firm’s profit per unit is the difference between price and average total cost. Total profit equals profit per unit times the quantity produced. Total profit is given by the area of the shaded rectangle ATCmPmEF.
Once we have determined the monopoly firm’s price and output, we can determine its economic profit by adding the firm’s average total cost curve to the graph showing demand, marginal revenue, and marginal cost, as shown in the figure above, Computing Monopoly Profit. The average total cost (ATC) at an output of Qm units is ATCm. The firm’s profit per unit is thus Pm – ATCm. Total profit is found by multiplying the firm’s output, Qm, by profit per unit, so total profit equals Qm(Pm – ATCm)—the area of the shaded rectangle in the figure above.

Average Total Cost

The average total cost (ATC) is calculated by taking total cost and dividing by total output at each different level of output. Average costs are typically U-shaped on a graph.
How do we represent fixed costs in our producer theory model? Let’s assume a small barbershop has fixed costs equal to $150 per day. Average total cost is an average of our total variable cost (VC) and total fixed costs (FC). As such, it can be found by calculating (total VC + FC)/Q. Expanding this equation, we see it is equivalent to VC/Q+FC/Q which is average variable cost (AVC) + average fixed cost (AFC). Since we already have our AVC, all we have to do is add the FC/Q at each level of production.

ATC for Barbershop

So what is our ATC when we are producing 50 haircuts? Our AVC is $4.00. Our AFC at this point will be quite high at $150/50 = $3. This means our ATC is $4.00 + $3.00 = $7.00. Consider how AFC changes as we increase Q:
Q = 10; AFC = $150/10 = $15
Q = 20; AFC = $150/20 = $7.5
Q = 30; AFC = $150/30 = $5
Q = 150; AFC = $150/150 = $1.
Since the only effect of an increase of inputs is spreading FC out among more units, AFC is always falling as Q increases.
Since AVC = ATC – (FC/Q), at low levels of Q, FC/Q is high. This means that AVC is < ATC by a significant amount. At high levels of Q, FC/Q is low. This means AVC is < ATC by a small amount. As Q increases, FC/Q approaches zero and AVC and AFC converge, as seen in the figure above. Why are Total Cost and Average Cost Not on the Same Graph? Total cost, fixed cost, and variable cost each reflect different aspects of the cost of production over the entire quantity of output being produced. These costs are measured in dollars. In contrast, marginal cost, average cost, and average variable cost are costs per unit. In the previous example, they are measured as cost per haircut. Thus, it would not make sense to put all of these numbers on the same graph, since they are measured in different units ($ versus $ per unit of output). It would be as if the vertical axis measured two different things. In addition, as a practical matter, if they were on the same graph, the lines for marginal cost, average cost, and average variable cost would appear almost flat against the horizontal axis, compared to the values for total cost, fixed cost, and variable cost. Using the figures from the previous example, the total cost of producing 40 haircuts is $296, but the average cost is $296/40, or $7.4. If you graphed both total and average cost on the same axes, the average cost would hardly show. Average total cost—along with related calculations, such as total variable cost, total fixed cost, total cost, average variable cost, average fixed cost, and marginal cost—can be used to determine the costs associated with a firm’s short run. Opportunity Cost People face choices at every turn: in deciding to go to the hockey game tonight, you may have to forgo a concert, or you will have to forgo some leisure time this week to earn additional income for the hockey game ticket. In economics we say that these limits or constraints reflect opportunity cost. The opportunity cost of a choice is what must be sacrificed when a choice is made. That cost may be financial, it may be measured in time, or simply defined by the foregone alternative. Opportunity costs play a determining role in markets. It is precisely because individuals and organizations have different opportunity costs that they enter into exchange agreements. If you are a skilled plumber and an unskilled gardener, while your neighbor is a skilled gardener and an unskilled plumber, then you and your neighbor not only have different capabilities, you also have different opportunity costs, and you could gain by trading your skills. Fixing a leaking pipe has a low opportunity cost for you in terms of time: you can do it quickly. But pruning your apple trees will be costly because you must first learn how to avoid killing them, and this research may require many hours. Your neighbor has exactly the same problem, with the tasks in reverse positions. In a sensible world you would fix your own pipes and your neighbor’s pipes, and he or she would ensure the health of the apple trees in both backyards. If you reflect upon this “sensible” solution—one that involves each of you achieving your objectives while minimizing the time input—you will quickly realize that it resembles the solution provided by the marketplace. You may not have a gardener as a neighbor, so you buy the services of a gardener in the marketplace. Likewise, your immediate neighbor may not need a leaking pipe repaired, but many others in your neighborhood do, so you can sell your service to them. You each specialize in the performance of specific tasks as a result of having different opportunity costs or different efficiencies. Economists think of cost in a slightly quirky way that makes sense once you give it further thought. We use the term opportunity cost to remind you occasionally of our idiosyncratic notion of cost. For an economist, the cost of buying or doing something is the value that one forgoes in purchasing the product or undertaking the activity of the thing. For example, the cost of a university education includes the tuition and textbook purchases, as well as the wages that were lost during the time the student was in school. Indeed, the value of the time spent in acquiring the education is a significant cost of acquiring the university degree. However, not all costs are opportunity costs. Room and board would not be an opportunity cost since one must eat and live whether one is working or at school. Room and board are a cost of an education only insofar as they are expenses that are only incurred in the process of being a student. Similarly, the expenditures on activities that are precluded by being a student—such as hang-gliding lessons, or a trip to Europe—represent savings. However, the value of these activities has been lost while you are busy for this course. Opportunity cost is defined as the value of the best forgone alternative. This definition emphasizes that the cost of an action includes the monetary cost as well as the value forgone by taking the action. The opportunity cost of spending $19 to download songs from an online music provider is measured by the benefit that you would have received had you used the $19 instead for another purpose. The opportunity cost of a puppy includes not just the purchase price but the food, veterinary bills, carpet cleaning, and time value of training. Owning a puppy is a good illustration of opportunity cost, because the purchase price is typically a negligible portion of the total cost of ownership. Yet people acquire puppies all the time, in spite of their high cost of ownership. Why? The economic view of the world is that people acquire puppies because the value they expect exceeds their opportunity cost. That is, they reveal their preference for owning the puppy, as the benefit they derive must apparently exceed the opportunity cost of acquiring it. Even though opportunity costs include nonmonetary costs, we will often monetize opportunity costs by translating them into dollar terms for comparison purposes. Monetizing opportunity costs is valuable, because it provides a means of comparison. What is the opportunity cost of 30 days in jail? It used to be that judges occasionally sentenced convicted defendants to “30 days or 30 dollars,” letting the defendant choose the sentence. Conceptually, we can use the same idea to find out the value of 30 days in jail. Suppose you would pay a fine of $750 to avoid the 30 days in jail, but would serve the time instead to avoid a fine of $1,000. Then the value of the 30-day sentence is somewhere between $750 and $1,000. In principle there exists a critical price at which you’re indifferent to doing the time or paying the fine. That price is the monetized or dollar cost of the jail sentence. The same process of selecting between payment and action may be employed to monetize opportunity costs in other contexts. For example, a gamble has a certainty equivalent, which is the amount of money that makes one indifferent to choosing the gamble versus the certain payment. Indeed, companies buy and sell risk, and the field of risk management is devoted to studying the buying or selling of assets and options to reduce overall risk. In the process, risk is valued, and the riskier stocks and assets must sell for a lower price (or, equivalently, earn a higher average return). This differential, known as a risk premium, is the monetization of the risk portion of a gamble. Buyers shopping for housing are presented with a variety of options, such as one- or two-story homes, brick or wood exteriors, composition or shingle roofing, wood or carpet floors, and many more alternatives. The approach economists adopt for valuing these items is known as hedonic pricing. Under this method, each item is first evaluated separately and then the item values are added together to arrive at a total value for the house. The same approach is used to value used cars, making adjustments to a base value for the presence of options like leather interior, GPS system, iPod dock, and so on. Again, such a valuation approach converts a bundle of disparate attributes into a monetary value. The conversion of costs into dollars is occasionally controversial, and nowhere is it more so than in valuing human life. How much is your life worth? Can it be converted into dollars? Some insight into this question can be gleaned by thinking about risks. Wearing seatbelts and buying optional safety equipment reduce the risk of death by a small but measurable amount. Suppose a $400 airbag reduces the overall risk of death by 0.01 percent. If you are indifferent to buying the airbag, you have implicitly valued the probability of death at $400 per 0.01 percent, or $40,000 per 1 percent, or around $4,000,000 per life. Of course, you may feel quite differently about a 0.01 percent chance of death compared with a risk 10,000 times greater, which would be a certainty. But such an approach provides one means of estimating the value of the risk of death—an examination of what people will, and will not, pay to reduce that risk. Consider the following figure, which shows the number of weeks an average human lives. Sometimes feels like our lives are made up of a countless number of weeks. But there they are—fully countable—staring you in the face. This isn’t meant to scare you, but rather to emphasize that a rational consumer doesn’t ignore time, but incorporates it into the analysis of any decision they make. Weeks in the Average Human Lifespan So, how do you “spend” your time? In economics, we want to place a value on each different opportunity we have so we can compare them. What if your friends were to ask you if you want to go out to the club? How much do you value that experience? As economists, we want to measure the happiness you will get from this experience by finding your maximum willingness to pay. Let’s say that for a five-hour night at the club, the most you are willing to pay is $100. Seem high? If you have gone clubbing, this is likely close to what you paid for it. Suppose the costs of going clubbing are $50 ($15 cover, $20 for drinks, and $15 for a ride home). With that analysis it seems like you should go, but so far we have only considered the explicit costs of the experience. An explicit cost represents a clear direct payment of cash (whether actual cash or from debit, credit, etc). But what about your time? We must consider time as another cost of the action. How do we measure time? Simple: what else could we be doing with that time? Assume you also work as a server at the campus pub, where you get paid $15 an hour (including tips). This makes it easy to put a dollar amount on your time. For five hours of clubbing, you are forgoing the opportunity to earn $75 ($15 * 5). This is your implicit cost for clubbing, or the cost that has been incurred but does not result in a direct payment. It is important to note that the implicit costs are the benefit of the next-best option. There are an infinite number of things we could be doing with our time, from watching a movie to studying economics, but for implicit costs we only consider the next best. If we took them all into account our costs would be infinite. Consider the two options side by side, as shown below. Opportunity Cost Comparison for Clubbing This comparison shows us something interesting. Even though you are willing to pay $100 to go out clubbing, our “happiness” from working is greater. A rational consumer would chose to work. The $75 we could be earning from working is equal to our implicit costs of going out since, rather than going clubbing, we could be making money for the five hours. To truly consider costs we must always consider our opportunity costs, which include the implicit and explicit costs of an action. Calculating Opportunity Costs In this example, if you were to go clubbing opportunity costs are: Explicit costs (cover, drinks, and ride home) : $50 Implicit costs (forgone income from five hours) : $75 Opportunity costs : $125 Should you go clubbing? You are only willing to pay $100, and your opportunity costs are $125, so no! Does this mean you should never go out? Not at all. You just may be surprised that your willingness to pay may be well over $100. Scarcity This consideration of opportunity cost is rooted in an understanding that all resources are scarce. Both time and financial resources are scarce. Being a rational decision maker means considering the scarcity of all resources associated with an action. As decision makers, we have to make trade-offs on what we do with finite resources. This leads us to a fairly simple conclusion. We should do something if the benefits outweigh the costs. The key insight is that the costs we are referring to are opportunity costs, which consider the next best alternative use of our resources. Making Decisions We have now looked at how to analyze two options, but how do we make the decision? We can lay the process out in three steps: 1. Find your willingness to pay (or wage you would earn) from the option you are considering and the next-best alternative. 2. Subtract the explicit costs from each option to find your “happiness” level. 3. Choose the option that makes you “happier.” If we want to change this into the process for a binary decision (yes-or-no decision): 1. Add up all the benefits of an action. 2. Subtract all costs explicit and implicit. 3. If benefits are greater than costs, this is the right choice. It is important to note that not all decisions are binary. Sunk Costs Just as it is important to understand the costs that should be considered in decision making, it is important to understand what costs should not. Consider the two options you may have when you wake up: do you work out or sleep in? Have you ever convinced yourself to get out of bed by reminding yourself that you paid $60 for your monthly gym membership? Well, you fell victim to a common logical fallacy. A sunk cost is a cost that, no matter what, is unrecoverable. As such it should have no impact on future decision making. This may sound strange, but consider your two options using the analysis learned above for making decisions. Opportunity Cost Comparison for Working Out Following our steps, we find the maximum willingness to pay for each option, subtract the explicit costs, and compare the happiness from each. It does not matter that we spend $60 on a gym membership because no matter what we do we can’t get that money back. With this willingness to pay reflected in the table, the better option is to sleep in, with an opportunity cost of $20. Notice that the $60 is not included as an explicit cost because it is not an additional cost we have to incur as a result of working out. Since we have already paid the $60, it is no longer something we consider. Sunk Costs & Sunk costs aren’t exclusive to gym memberships, in fact, the sunk cost fallacy is common in big business and government. Ever heard someone explain, “we’ve invested too much in this project to back out now?” Even if you have not, it sounds fairly logical; unfortunately it is not. Consider a mining company that has invested $5 million in the infrastructure of a mine. After new information is revealed, they learn of another, richer mine site that they can mine for $4 million, with projected revenues of $8 million. The current mine site will cost $1 million to extract the remaining resources ($4 million projected revenue). What should the company do? Decision-Making Matrix Showing Sunk Costs As shown, the total profits from the new site are higher, so despite the fact they have invested $5 million in the old site, they should abandon it and mine the new one. The conclusion: sunk costs are irrelevant for decision making. Profit Maximization Briefs: Profit Maximization Profit-maximizing behavior is always based on the marginal decision rule: Additional units of a good should be produced as long as the marginal revenue of an additional unit exceeds the marginal cost. The maximizing solution occurs where marginal revenue equals marginal cost. As always, firms seek to maximize economic profit, and costs are measured in the economic sense of opportunity cost. Indeed, the monopoly could seek out the profit-maximizing level of output by increasing quantity by a small amount, calculating marginal revenue and marginal cost, and then either increasing output as long as marginal revenue exceeds marginal cost or reducing output if marginal cost exceeds marginal revenue. This process works without any need to calculate total revenue and total cost. Thus, a profit-maximizing monopoly should follow the rule of producing up to the quantity where marginal revenue is equal to marginal cost—that is, MR = MC.  If you find it counterintuitive that producing where marginal revenue equals marginal cost will maximize profits, working through the numbers will help: · Step 1: Remember that marginal cost is defined as the change in total cost from producing a small amount of additional output. · Step 2: Note that in the table below, as output increases from one to two units, total cost increases from $1,500 to $1,800. As a result, the marginal cost of the second unit will be: · Step 3: Remember that, similarly, marginal revenue is the change in total revenue from selling a small amount of additional output. · Step 4: Note that in the table below, as output increases from one to two units, total revenue increases from $1,200 to $2,200. As a result, the marginal revenue of the second unit will be: Marginal profit in the table above is the profitability of each additional unit sold. It is defined as marginal revenue minus marginal cost. Finally, total profit is the sum of marginal profits. As long as marginal profit is positive, producing more output will increase total profits. When marginal profit turns negative, producing more output will decrease total profits. Total profit is maximized where marginal revenue equals marginal cost. In this example, maximum profit occurs at four units of output. MC=changeintotalcostchangeinquantityproducedMC=changeintotalcostchangeinquantityproduced   A perfectly competitive firm will also find its profit-maximizing level of output where MR = MC. The key difference with a perfectly competitive firm is that in the case of perfect competition, marginal revenue is equal to price (MR = P), while for a monopolist, marginal revenue is not equal to the price, because changes in quantity of output affect the price. MC=$1,800−$1,5001MC=300MC=$1,800−$1,5001MC=300 MR=changeintotalrevenuechangeinquantitysoldMR=changeintotalrevenuechangeinquantitysold   MR=$2,200−$1,2001MR=$1,000MR=$2,200−$1,2001MR=$1,000 Marginal Revenue, Marginal Cost, Marginal Profit, and Total Profit Quantity Marginal revenue Marginal cost Marginal profit Total profit 1 1,200 1,500 –300 –300 2 1,000 300 700 400 3 800 400 400 800 4 600 600 0 800 5 400 700 –300 500 6 200 700 –500 0 7 0 1,400 –1,400 –1,400