Question

Hot Air Balloon Rides is a single-price monopoly. Columns 1 and 2 of the table set out the market demand schedule and columns 2 and 3 set out the total cost schedule. $$\begin{array}{ccc} \begin{array}{c} \text { Price } \\ \text { (dollars } \\ \text { per ride } ) \end{array} & \begin{array}{c} \text { Quantity } \\ \text { (rides } \\ \text { per month) } \end{array} & \begin{array}{c} \text { Total cost } \\ \text { (dollars } \\ \text { per month) } \end{array} \\ \hline 220 & 0 & 80 \\ 200 & 1 & 160 \\ 180 & 2 & 260 \\ 160 & 3 & 380 \\ 140 & 4 & 520 \\ 120 & 5 & 680 \end{array}$$ Find Hot Air's profit-maximizing output and price and calculate the firm's economic profit.

Short answer

The output is 2 rides and the price is 180 with an economic profit of 20 dollars.

Step-by-step solution

Determine Total Revenue (TR)

Total Revenue (TR) is calculated by multiplying the price per ride by the quantity of rides. For example, for price 200 and quantity 1, TR would be 200 * 1 = 200.

Calculate the Marginal Revenue (MR)

Marginal Revenue (MR) is the change in Total Revenue for an additional unit sold. For example, when increasing from 0 to 1 ride, TR increases from 0 to 200, so MR = 200 - 0 = 200.

Calculate the Marginal Cost (MC)

Marginal Cost (MC) is the change in Total Cost when an additional unit is produced. For instance, the total cost for 0 rides is 80, and for 1 ride it is 160, so MC = 160 - 80 = 80.

Compare MR and MC to determine the profit-maximizing output

The profit-maximizing output occurs where MR = MC. Compute MR and MC for each level of output and find the quantity where they are equal or MR is just greater than or equal to MC.

Calculate Total Profit

Total Profit is given by Total Revenue minus Total Cost (TR - TC). At the profit-maximizing output, plug in TR and TC to find the economic profit.

Key concepts

Monopoly Pricing

In a monopoly, a single firm controls the market. This means they have significant power over the prices they set. Unlike in competitive markets, a monopoly sets a price that maximizes its own profit rather than taking the market price as given. The firm will choose the price where its profit is highest, considering both the demand and its costs.
To determine the best price, a monopoly looks at the demand schedule and calculates both the total revenue and cost for different levels of output. By comparing these, the firm finds the output level that balances higher prices against lower quantities demanded.

Total Revenue

Total revenue (TR) is a key concept to understand in economics. It represents the total amount of money a firm receives from selling its product. You calculate it by multiplying the price per unit by the quantity of units sold.
For Hot Air Balloon Rides, if you sell 3 rides at \(160 each, the total revenue is 160 * 3 = \)480.
Understanding total revenue helps firms to see how changes in price and output affect their overall income. It's a starting point to calculate other important metrics like profit.

Marginal Revenue

Marginal revenue (MR) is the additional revenue gained from selling one more unit of a product. It helps firms understand how much extra income they will make if they increase their output by one unit.
To calculate MR, you need to know the change in total revenue when one more unit is sold. For example, if TR goes from \(200 to \)380 when output increases from 1 to 2 rides, MR is \[(380 - 200) = 180\].
Marginal revenue is crucial for deciding the optimal output level. Firms will keep increasing output as long as MR is greater than or equal to marginal cost (MC).

Marginal Cost

Marginal cost (MC) is the increase in total cost when producing one additional unit of a product. It shows how much more it costs to make one more ride.
You calculate it by finding the change in total cost as output increases. For example, if total cost goes from \(160 to \)260 when increasing output from 1 to 2 rides, MC is \[(260 - 160) = 100\].
Understanding MC is important for maximizing profit. A firm will continue to produce more units as long as the revenue from selling an additional unit (MR) is higher than or equal to the MC.

Economic Profit

Economic profit is the difference between total revenue and total cost. It shows the actual profit a firm makes after considering all costs, including opportunity costs.
To find economic profit, you subtract total cost (TC) from total revenue (TR). For example, if TR is \(480 and TC is \)380, the economic profit is \[(480 - 380) = 100\].
This measure is important because it shows not just accounting profit (which considers only explicit costs) but also how well a firm is doing overall. A positive economic profit indicates that the firm is doing better than its next best alternative.