Step Two – Revenue and Profit
Next we examine the revenue and profit for the company. In particular, we will see how selling price influences profit. Use the cost function from Step One.
Comprehension
1) The revenue from selling a barrel of oil also depends on several factors. What do you think some of these factors are?
2) What is profit? What information do you need to determine the profit?
3) How does the selling price affect profit?
Acquisition
Some of the terms we introduced in this section (revenue, profit, marginal revenue, marginal profit) may be unfamiliar to you. To see precise definitions and examples, click here or see the menu topic.
Application
We first assume that a particular selling price has been set.
Assumptions
Selling price is $15 per barrel.
The cost function derived in Step One is valid.
Questions
1) Write the expression which defines the revenue function.
2) What is the marginal revenue?
3) Write the expression which defines the profit function.
4) What is the smallest number of barrels that should be sold for the operation to be profitable? What is the largest number?
5) How many barrels should be sold to give maximum profit? What is the maximum profit.
6) Verify that maximum profit occurs when marginal revenue = marginal cost.
Reflection
1) Suppose that the selling price for a barrel of oil increases to $20 per barrel.
a) Write the new revenue function and profit function.
b) What is the smallest number of barrels that should be sold for the operation to be profitable? What is the largest number?
c) How many barrels should be sold to give maximum profit? What is the maximum profit.
d) Verify that maximum profit occurs when marginal revenue = marginal cost.
2) Repeat question 1) with the assumption that the selling price for a barrel of oil decreases to $14.50.
3) Compare the three profit functions. What conclusions can you draw?
4) Would it make sense for the producer to continue to raise the price of oil? Why?
