Fig. 1 shows simplified cost and revenue curves prepared by a bakery firm that supplies packed oatcakes to local shops. The manager is considering a new pro...
Question 1 Report
Fig. 1 shows simplified cost and revenue curves prepared by a bakery firm that supplies packed oatcakes to local shops. The manager is considering a new production run. The demand curve shows the price that shops will pay at each quantity. The firm’s marginal revenue, MR, is below demand because selling extra packs requires a lower price. Its marginal cost, MC, rises as the bakery uses overtime labour and less efficient oven space. The manager uses the usual economic assumption that the firm seeks to maximise profit. At an output of 400 packs, average cost is £5 per pack. Government food-safety rules place no cap on production, and the manager assumes that market demand and all other costs remain unchanged during the week.
(a) Identify the weekly quantity at point X that is consistent with the profit-maximising assumption. [2]
(b) Explain why a profit-maximising firm uses the condition MC = MR when selecting output. [3]
(c) Calculate the bakery’s total profit at 400 packs. Show your working. [4]
(d) Explain why the bakery might produce fewer than 400 packs even if its manager wishes to maximise profit. [5]
(e) Explain the likely effect on the firm’s profit-maximising quantity if the price of oats increases and raises marginal costs at every output level. [6]
Answer Details
(a) The profit-maximising quantity is 400 packs per week, because point X is where marginal cost equals marginal revenue, \(MC=MR\). [2]
(b) Below \(MC=MR\), an extra pack adds more to revenue than to cost, so producing it raises profit. Above this output, marginal cost exceeds marginal revenue, so further output reduces profit. [3]
(c) At 400 packs, price is £8 and average cost is £5.
\[TR=£8\times400=£3200\]
\[TC=£5\times400=£2000\]
\[\text{Profit}=£3200-£2000=£1200\]
Therefore total profit is £1200. [4]
(d) Output could be below 400 if skilled labour is unavailable, oven capacity is insufficient, or the firm cannot obtain enough oats or packaging. It may also face lower actual demand than forecast, imperfect information about costs or revenue, or choose another objective such as maintaining quality or reducing waste. [5]
(e) Dearer oats raise marginal cost at every output, shifting the MC curve upwards. MC then equals MR at a lower output, so the firm reduces its profit-maximising quantity. Fewer packs are supplied; each additional pack costs more to produce; and profit is likely to fall if demand and MR are unchanged. [6]
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