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The McGraw-Hill Series Managerial Economics Thomas Maurice eighth edition Chapter 14 Advanced Techniques for Profit Maximization.

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Presentation on theme: "The McGraw-Hill Series Managerial Economics Thomas Maurice eighth edition Chapter 14 Advanced Techniques for Profit Maximization."— Presentation transcript:

1 The McGraw-Hill Series Managerial Economics Thomas Maurice eighth edition Chapter 14 Advanced Techniques for Profit Maximization

2 Managerial Economics 2 The McGraw-Hill Series 2 Advanced Techniques for Profit Maximization Multiplant firms Cost-plus pricing Multiple markets Price discrimination Multiple products Strategic entry deterrence

3 Managerial Economics 3 The McGraw-Hill Series 3 Multiple Plants If a firm produces in 2 plants, A & B Allocate production so MC A = MC B Optimal total output is that for which MR = MC T For profit-maximization, allocate total output so that MR = MC T = MC A = MC B

4 Managerial Economics 4 The McGraw-Hill Series 4 A Multiplant Firm (Figure 14.1)

5 Managerial Economics 5 The McGraw-Hill Series 5 Cost-Plus Pricing Common technique for pricing when firms do not wish to estimate demand & cost conditions to apply the MR = MC rule for profit-maximization Price charged represents a markup (margin) over average cost: P = (1 + m)ATC Where m is the markup on unit cost

6 Managerial Economics 6 The McGraw-Hill Series 6 Cost-Plus Pricing Does not usually produce profit- maximizing price Fails to incorporate information on demand & marginal revenue Uses average, not marginal, cost

7 Managerial Economics 7 The McGraw-Hill Series 7 Practical Problems with Cost-Plus Pricing (Figure 14.3)

8 Managerial Economics 8 The McGraw-Hill Series 8 Cost-Plus Pricing (Constant Costs) Yields profit-maximizing price when optimal markup, m*, is applied to AVC : P = (1 + m*)AVC And optimal markup is chosen according to the following relation: Where E* is price elasticity at profit-maximizing point of firms demand

9 Managerial Economics 9 The McGraw-Hill Series 9 Cost-Plus Pricing (Constant Costs) When demand is linear & costs are constant ( SMC = AVC ), profit- maximizing value for E* is: Where A is price-intercept of linear demand curve & AVC is constant

10 Managerial Economics 10 The McGraw-Hill Series 10 Multiple Markets If a firm sells in two markets, 1 & 2 Allocate output (sales) so MR 1 = MR 2 Optimal total output is that for which MR T = MC For profit-maximization, allocate sales of total output so that MR T = MC = MR 1 = MR 2

11 Managerial Economics 11 The McGraw-Hill Series 11 Price Discrimination Method in which firms charge different groups of customers different prices for the same good or service

12 Managerial Economics 12 The McGraw-Hill Series 12 Deriving Total Marginal Revenue (Figure 14.4)

13 Managerial Economics 13 The McGraw-Hill Series 13 Profit-Maximization with Two Markets (Figure 14.5)

14 Managerial Economics 14 The McGraw-Hill Series 14 Multiple Products Related in consumption For two products, X & Y, produce & sell levels of output for which MR X = MC X and MR Y = MC Y MR X is a function not only of Q X but also of Q Y (as is MR Y ) -- conditions must be satisfied simultaneously

15 Managerial Economics 15 The McGraw-Hill Series 15 Multiple Products Related in production as substitutes For two products, X & Y, allocate production facility so that MRP X = MRP Y Optimal level of facility usage in the long run is where MRP T = MC For profit-maximization: MRP T = MC = MRP X = MRP Y

16 Managerial Economics 16 The McGraw-Hill Series 16 Multiple Products Related in production as complements To maximize profit, set joint marginal revenue equal to marginal cost: MR J = MC If profit-maximizing level of joint production exceeds output where MR J kinks, units beyond zero MR are disposed of rather than sold Profit-maximizing prices are found using demand functions for the two goods

17 Managerial Economics 17 The McGraw-Hill Series 17 Profit-Maximizing Allocation of Production Facilities (Figure 14.7)

18 Managerial Economics 18 The McGraw-Hill Series 18 Profit-Maximization with Joint Products (Figure 14.9)

19 Managerial Economics 19 The McGraw-Hill Series 19 Strategic Entry Deterrence Established firm(s) makes strategic moves designed to discourage or prevent entry of new firm(s) into a market Two types of strategic moves Limit pricing Capacity expansion

20 Managerial Economics 20 The McGraw-Hill Series 20 Limit Pricing Established firm(s) commits to setting price below profit- maximizing level to prevent entry Under certain circumstances, an oligopolist (or monopolist), may make a credible commitment to charge a lower price forever

21 Managerial Economics 21 The McGraw-Hill Series 21 Limit Pricing: Entry Deterred (Figure 14.11)

22 Managerial Economics 22 The McGraw-Hill Series 22 Limit Pricing: Entry Occurs (Figure 14.12)

23 Managerial Economics 23 The McGraw-Hill Series 23 Capacity Expansion Established firm(s) can make the threat of a price cut credible by irreversibly increasing plant capacity When increasing capacity results in lower marginal costs of production, the established firms best response to entry of a new firm may be to increase its own level of production Requires established firm to cut its price to sell extra output

24 Managerial Economics 24 The McGraw-Hill Series 24 Excess Capacity Barrier to Entry (Figure 14.13)

25 Managerial Economics 25 The McGraw-Hill Series 25 Excess Capacity Barrier to Entry (Figure 14.13)


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