Review of Chapter 2: Optimal Decisions Using Marginal Analysis

Key concepts: demand, inverse demand, total revenue, marginal revenue, total cost, fixed
cost, variable cost, marginal cost, profits, marginal profit.

Economic reasoning

1. If MR=$12,000 at Q=3 lots, what does it mean? What does MC=$100 at Q=3
mean?
2. When MR is greater or lower than MC (or, Mπ>0 or Mπ<0), how should the firm
adjust Q to increase profit?
3. Q* occurs where MR=MC or Mπ=0.
4. When MR> 0 or MR<0, how should the firm adjust Q to increase revenue?
5. Q*R occurs where MR=0.
6. MC=dC/dQ=dVC/dQ.
7. Marginal analysis: make a change in the level of output if and only if this
generates an increase in profit (revenue). Keep moving, always in the direction of
increased profits (revenue), and stop when no further output change will help.

Graphical Skill:

1. Understand that MR, MC and Mπ are slopes of the relevant functions.

2. Learn to draw MR (linear, connecting two points on the curve) and MC (constant,
a horizontal line) curves. Use these curves to show Q* or Q*R , and to
demonstrate the effect on Q* of changes in MC.
3. Draw a demand curve (linear).

Problem Solving Skill:

1. Use demand or inverse demand equations to estimate price or quantity. For

example, at a certain P, what is Q?
2. Identify Q* or Q*R under different conditions of demand and cost. Find out the
corresponding P*, R* and π*. How do firms respond to changes in fixed cost, MC
and demand?
3. Identify managers’ goals with revenue sharing arrangement: e.g., max 20%R, or
max 80%R – C. Find out appropriate income for both parties.