2. Marginal cost New York & Co. is considering a limited edition denim jacket. B

Question

2. Marginal cost

New York & Co. is considering a limited edition denim jacket. Because it is so special, the first few will sell for a very high price, the next for less, and so on. A curve on a graph is used to estimate the price of each jacket. It says that jacket n will be priced at $1500 / n. So the first jacket will be $1500, the second $750, and the third $500.

a. The manufacturing equipment costs $7,000, but the marginal cost of each jacket (labor and material) is only $8. How many jackets should the company produce?

b. What if a less automated system is selected, so that the equipment costs $5000 and the marginal cost of a jacket is $10?

Explanation / Answer

Price is inversely related to Demand therefore demand function is :

P=1500/Q

MC=$8

Here MC is considered as Supply Function

MR function has the same y-intercept as the inverse demand function, the x-intercept of the MR function is one-half the value of the demand function, and the slope of the MR function is twice that of the inverse demand function. This relationship holds true for all linear demand equations.The importance of being able to quickly calculate MR is that the profit-maximizing condition for firms regardless of market structure is to produce where marginal revenue equals marginal cost (MC).

So MR=2(1500/Q)

Now MC=MR

8=2*(1500/Q)

Q=375

Given TC= 7000

TR=P*Q so 1500*375 = 562500

b. Now MC=10

So MR=2(1500/Q)

MC=MR

10=2(1500/Q)

Q=300

Given the equipment costs $5000

TR=P*Q =300*1500 =450000

Thus TR decreases as quantity produced is reduced in second question.

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