How would a company's profitability in their toothpaste division would be impacted by an expansion. Assess the profit potential using marginal analysis.
It is assumed that the toothpaste market is perfectly competitive and the current price of a case of toothpaste is $42.00. Estimated its marginal cost function to bas follows: MC=.006Q.
1. How many cases of toothpaste should be produced in order to maximize profits.
2. What happens if its decided to raise prices unilaterally in this toothpaste market?
3. What results from the profit maximizing level of output if the market price suddenly rose to $54 per case? Why the output level changes?
4. Would the company benefit by advertising in this perfectly competitive market?
5. What would happen to the price of toothpaste, would it rise or fall? What would happen to the profits the company makes?
The information that we have in the problem is:
Price = $42
Market is competitive
The marginal cost is MC = 0.006Q
1. Profit is the same thing as the producer surplus. In this case the supplier can do nothing about the price, since the market is competitive. In a competitive market all producers are price takers. Therefore, the price has to be $42 and hence the marginal revenue is $42. The profit maximizing condition is MR = MC. So we have:
0.006Q = 42
or Q = 42/0.006 = 7000.
Hence, the company should produce 7000 cases.
2. If they decide to raise the price unilaterally they will not be able to sell anything: remember ...
This solution utilizes marginal analysis.