Costs Concepts

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Costs Concepts and Profit Maximization

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ECO 561

Aug 9, 2009

Will Bury has an innovative product, a digital audio book, which if he markets using the basic economic concepts like price and demand, can be a very lucrative business. He has a few options he must decide between before going full steam ahead with the venture. He can use either high school graduates at $10 per hour or get labor from overseas at $2 per hour. He currently offers two kinds of books, a copyrighted version at $15 and the non-copyrighted one at $10. He thinks he has some room to increase the price of the books and still make a profit. He needs to weigh all his alternatives based on good economic sense. That is the only way to have some guarantee of success.

According to Anderson and Ross (2005) - The “economic problem” to be solved in neoclassical economics is for a firm or individual to maximize an objective function in the face of constraints, cost and otherwise. The firm faces constraints both with the physical nature of production (the production function) and costs (due to the production function and input prices), all of which are a “given” in the neoclassical theory of the firm.

Ultimately, then, according to the theory, the firm has a profit function of total revenues minus total costs. To maximize this profit (objective) function, one sets the first derivative of this function to zero, with the solution ultimately being that in order to maximize profit, the firm sets output where marginal costs equal to marginal revenue. Thus, the problem for the firm to solve is to determine where to locate output, given costs and demand for the product to be sold. (Anderson and Ross, 2005)

“The arc elasticity of demand refers to the relationship between changes in price and the subsequent change in quantity demanded. The arc elasticity formula is used if the change in price is relatively large. It is...