Question

Leila runs a lawn mowing/maintenance service for busy homeowners. She has six potential customers and each is has a different maximum price they are willing to pay per week. The customers and the maximum price each is willing to pay each week is as follows:

Customer      Price
Lorraine      $40
Gilda            15
Jane            30
John            25
Bill            20
Dan            35

Leila's costs depend on the number of customers she has. Her costs (she has no sunk costs) appear in the following table:

# of customers per week            Total Cost
      1                  $22
      2                  $44
      3                  $66
      4                  $88
      5                  $110
      6                  $132

In Situation 7.3, if Leila has the optimal number of customers to have in order to maximize net benefit, she will earn a net profit or net benefit of

Select one:

a. $52

b. $40

c. $42

d. $32

Answer 1

The correct answer is (c) $42

Marginal cost is the additional cost incurred in order to produce one additional unit of output.

We can see from above that Total cost is increasing at a constant rate and Marginal cost of producing 4th unit is given by:

MC(4) = Total cost of producing 4 units - Total cost of producing 3 units

= 88 - 66 = 22 and Note that MC is also constant i.e. MC(1) = MC(2) = MC(3) = MC(4) = MC(5) = MC(6) = $22

In order to maximize profit a producer will sell his output to those people whose willingness to pay is greater than its marginal cost.

We can see from above that MC is constant and equals 22 and there are 4 people whose Willingness to pay is greater than MC = 22.

This producer will charge price according to there maximum willingness to pay and hence, Revenue = 40 + 35 + 30 + 25 = 130.(Assuming that it perfectly price discriminates)

Total cost of producing 4 units = 88.

=> Net profit = Revenue - Cost = 130 - 88 = 42

So, she will earn a net profit or net benefit of $42

Hence, the correct answer is (c) $42