MR = MC
A firm’s profit is defined as its total revenue minus its total cost. In symbols, p (Q) = R(Q) - C(Q). A firm that wishes to maximize its profits may find the corresponding output by differentiating p (Q) with respect to output and finding the output that equates the derivative to zero:
dp (Q)/dQ = dR(Q)/dQ - dC(Q)/dQ = MR - MC = 0. That is, profit maximization requires that, if the firm chooses to produce anything at all, it should equate marginal revenue and marginal cost. In the specific case of competitive firms, this takes the form P = MC. The second-order condition is:
Derivative of MR - MC < 0, or that marginal revenue cuts marginal cost from below.
However, we know that the maximum found by the procedure above is only a local maximum. We also need to check that the output at the beginning of the range of possible output does not provide greater profits. Specifically, we need to check profits where output is zero. If output is zero, then revenue is zero, variable cost is zero, and profit equals p (0) = 0 - (FC + 0); the firm loses an amount equal to its fixed costs. Naturally, then, the firm would only select this option if its losses at the MR = MC output were greater than this. Let Q* be the output that satisfies the MR = MC rule. Total profits at this point will be p (Q*) = PQ* - (FC + VC(Q*)). Profits at Q = 0 will be higher than at Q = Q* if and only if p (0) = -FC > PQ* - (FC + VC(Q*)) = p (Q*). Dividing both sides of this inequality by Q* and rearranging, the firm maximizes profit at Q = 0 if and only if P < (VC(Q*))/(Q*), that is, if and only if the firm’s price is less than its average variable cost at the MR = MC output. Since average variable cost is equal to marginal cost at the former’s minimum, we can state the complete short-run profit-maximizing rule as follows: produce at the output for which MR = MC, provided price is greater than minimum average variable cost; otherwise shut down.
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http://www.mhhe.com/economics/mcconnell15e/graphics/mcconnell15eco/common/dothemath/mrequalsmc.html
Goods/Flaws of the Lemonade Stand Game
Everyone should have already known that I love picking up flaws in issues like this.
Let me first say that I have made a virtual profit of $188.27 from the game, not a revenue =D
I believe that the game is not just about weather as a demand determinant. The main issue here is about obtaining and maintaining a strong consumer base. In the game, it is divided into the following 2 catagories:
1) Satisfaction
It refers to how much the consumers liked your product, in this case, lemonade. In the first few rounds, the percentage (%) satisfaction won't be high as we, as students, don't have the perfect knowledge of the good in question. We do not know what proportion of ingredients - lemonade, sugar and ice - will make a tasty jar of lemonade. We also do not know the initial market equilibrium price of lemonade. As such, our goods may appear in excess (if we set a price above the market price), since consumers are unwilling to pay for the product, resulting in a wastage of resourses. It may also appear to be in a shortage (if we set a price below the market price), since consumers will achieve greater consumer surplus/benefit and thus there will be a greater quantity of lemonade demanded. Apparently, my lemonades are usuall sold out for no good reason... However, we do know that consumers eye for icy cold drinks or food items when the weather is very hot.
In the process, through consumers comments such as "yucks!" and "hmmm", we can deduce whether or not they liked the lemonade made. From here, we can then adjust the proportions of ingredients used in per jar of lemonade to achieve greater consumer satisfaction. With this, the consumer satisfaction indicater will increase overtime and probably till maximum, like what I achieved in day 3 =D However, towards the end of the one month period (ie. day 24), I observed that consumer satisfaction rate has started to decrease till around 95% for me. In my opinion, this cannot be further improved back to 100% as when the time proceeds, some consumers may have lost interest in the lemonade produced. As such, the effect of consumers' taste and preferences set in. However, there is always some days when consumers' satisfaction is not maximum since one can never satisfy every single consumer.
2) Popularity
It refers to how popular your product is among the consumers, and thus ensuring a particular consumer base. It is just about knowing what the consumers liked and also what is the price that they are willing to pay for the lemonade at the given time period.
With this, I was able to determine the price to be set for lemonade on different days. These are the pricing policies I adopted:
a) When temperature is high, I increased the price of lemonade. This is because during hot weathers, demand for cold drinks will be more inelastic. Thus, an increase in price will lead to a less than proportionate decrease in quantity demanded for lemonade. As such, there will be a net increase in revenue. The opposite is done when temperature is low as the demand of cold drinks will be more elastic.
b) When I have achieved a strong consumer base, or high popularity, I began to increase the price of lemonade slowly. This is because the my product will have become more inelastic to price changes. Thus, an increase in price will lead to a less than proportionate decrease in quantity demanded for lemonade. In this case, however, the decrease in demand may be negligible since the number of consumers per day appears to be very low (<120). Thus, there will still be a net increase in revenue with price increase.
Apart from these, what I did was to adjust the number of ice used per cup during the different climatic conditions. I made use of this formula: number of ice = (temperature / 10). The result is rounded up to to nearest whole number if the weather is sunny or rounded down if it is cloudy, raining.
Having said those, I would like to discuss some flaws of the game:
1) During rainy days, temperature should not be very high. In some days, I received this situation of raining and 98oF
2) There is no competition (as what JiaWei said). However, in real world, there appears to have more than 1 lemonade stand and there are also substitudes such as soft drinks available. This will be cross-elasticity into the picture, which in this game, is not shown. Thus with more substitutes available, the lemonade becomes more price elastic as a change in price of other relevant drinks will cause a more than proportionate change in the demand for lemonade.
Back to the good points, the game still holds economic relevance.
It shows that the food and beverage industry, in this case, just drinks, is considerably a free market, since the set-up cost is low. Although there may be domination from F&N, Coka Cola etc, there still exist many small firms that brew and sell home-made drinks such as barley and herbal tea. The products are thus not homogeneous in nature as different producers will include different proportion of ingredients to achieve product differentiation and thus, attractiveness to consumers. The low set-up cost results in free entrance and exit of small firms, in this case, my small lemonade stand =D Producers and consumers also have the perfect knowledge of goods in question, which may be achieved after some trials. However, consumers' taste and preferences still holds the major determination factor to the demand of the good.
This game also shows partly internal economic of scale that could be experienced such as bulk purchases whereby if you were to purchase more, you will be able to save more, thus reducing cost price. Assuming that total revenue generated is the same, then there will also be a gain in profit.
What I would suggest is that, if there exist an IT-savy person in college, he/she may consider developing a related game such that it involves many players playing simultaneously in the same given scenario to illustrate the effects of cross elasticity of demand of good. There may also be different products invloved such as coffee or tea to illustrate this concept of cross elasticity. The game may also involve merger of firms to show how bigger firms may be more advantageous in the market, in terms of greater asset and specilisation.
When life gives you lemons, you make lemonade.
Geez, what an appropriate title for a post like this. maybe this quote was inspired by the game itself hee.
Anyhow, i was just thinking about this game, and as i can see it really does have quite a lot of economic relevance. The idea that everything you do affects the quality of your product, and therefore differentiating it from the one in the market. And of course, the key factor in this entire game is based on Price Elasticity concepts (well, at least more than the other elasticity concepts which i will be elaborating on later). Here, it seems really difficult to determine the price elasticity of the lemonade in the game until you actually try it (and hence being able to determine the result through varying the prices in the game and see how your quantity demanded changes). Typically, lemonade being not quite an essential, unless the weather is horribly hot and you're desperately in need of something cooling, it seems quite elastic - change quantity demanded varies more than proportionately with change in price. The game is interesting because it takes in weather into the equation as well, which can be a determinant of price elasticity, as mentioned earlier! Quite cool, huh!
But the fall back is that cross elasticity concepts and income elasticity concepts wont be as useful. The income of the customers are not displayed, and neither are changes in their incomes. The game also assumes no competitors, or at least you wont be able to check the status of your competitors. which means, these 2 concepts are effectively not applicable. Supply elasticity, however, if more useful. Due to the nature of lemonade, both in and outside the game, you can react really quickly to demand changes since the time taken to make lemonades is really short. the resources needed are also easily available. This means that supply can change more than proportionately with changes in price. however, this does not really tell us much, other than that you can quickly change supply to meet demands ie. change your supply on the next day if demand increases.
And so, i was thinking, how cool it would be to play a real-life lemonade stand game, with all the other classes! like. each class can be in charge of a lemonade store (perhaps online? or not?) and hence there will be cross elasticity! And income of customers can be manipulated by the game master (econs tutors?), so income elasticity comes into play as well! So letsay every term classes earning subnormal profit will be eliminated, the number of classes remaining in the game will slowly decrease! perhaps to the stage of an oligopoly? an alternative would be to simulate perfect competition! Where there is freedom of entry and exit, so classes who have been eliminated can return into the game to take away the supernormal profits of certain classes, so that in the long run, there will be normal profits. And of course, we could throw in numerous variables such as weather changes, economic recessions, freak lemon plantation failure, etc etc. And include mergers/acquisitions at some point in the game! Ahah okay now this whole idea sounds really complex xD Point is, simulating such market games will really let us understand how elasticity concepts work, what happens in a certain market structure, and how to determine prices!
A bold suggestion (:
Lemonade Stand Game
I’m posting one of my ultimate favourite games of all time and it has to do with Econs! It’s really frustrating, but really really fun! I think some of you may have played this before!
The
Lemonade Stand Game.
It’s usually used for teaching little kids Maths, and it involves some trial & error but it’s actually pretty complex. You have to gauge customer demand of your lemonade based on a) temperature, b) weather, c) your lemonade, etc.
It’s also pretty frustrating when you go bankrupt. When you price your lemonade too low to increase demand (which is elastic) you make subnormal profit and you go bankrupt faster. I have yet to beat this game yet!
Hope you have some fun and relieve some stress!
- Lim Yu
Wanted! - Board Game
Was digging my room when I found this board game bought in Secondary Two. I was advertising this board game on television then =D
I find it rather economics-related. A player plays both roles as a consumer and as a producer. The whole idea of the game revolves around maximising profits. As a producer, the player plans whether to embark on businesses (eg. food, transport). As a consumer, the player is involved in stock exchanges, deposits etc. The game simulates the world where the economy is unpredictable (ie. in the game, there is a wheel to decide on the state of economy). As a consumer, the player also decides on whether or not to purchase luxurious goods/services (eg. travels and cruise, house and car), thus there is the concept of Price Elasticity of Demand and Income Elasticity of Demand involved. It is also about minimising costs (by replacing public transport with car) and future price expectations (decisions to sell/buy shares). So the whole idea, in my opinion, is mainly to maximise consumers' and producers' surpluses/profits.
Isn't this game interesting? =D
The Wisdom of Crowds
I’ve been reading
The Wisdom of Crowds: Why the Many Are Smarter Than the Few by James Surowiecki recently, and other than being a pretty popular book arguing against ‘common sense’, it also argues with economic principles.
One of the reasons I like this book is because some principles are explained pretty clearly, and you don't need that much economic background to understand his examples. But it does help, and I find myself appreciating the book much more now that I've taken Econs.
One of the relevant section that I would like to share is his example of American TV corporations. There is a season during which channels get their ratings, and so against all common sense American TV channels schedule all their newest and most popular TV programmes at the same time. The reason it’s bad for consumers is that when it’s
not ratings season, consumers get re-runs and not-so-good TV shows. Now, James Surowiecki argues that corporations should have a friendly agreement because it would benefit them as well as the consumers; Americans wouldn’t experience the opportunity cost of missing
House on Fox just because
Heroes is showing on NBC. (This is my purely hypothetical example, in fact they show on different days!) And consumers tuning in to watch a channel helps it, because they can gain ad revenue while consumers gain enjoyment.
So this got me thinking.
Why do American consumers let their TV corporations get away with it? Because it's an oligopoly. There are many barriers to entry, including licensing rights, advertising, customer loyalty, etc. so much so that new, small channels find it very hard to get on air and get popular, and if they do, to survive.
Something new to the world of television programming is cross-elasticity of television programmes and online TV. It might be because they weren’t very legal or widespread methods a few years ago. Some channels have already put lots of their episodes online, so you can catch it even when you miss it. So they probably have a pretty high positive cross-elasticity with the television programmes. So consumers can get to watch
Heroes on TV while catching
House on the computer and still get the same satisfaction as having watched
House on TV. And having customers visit their website also lets channels gain ad revenue, so it's a win-win situation; the channels retain their customer base and consumers get to watch their favourite TV shows.
And the channels
are pretty clever after all. Despite having kind of inexplicable competitive strategies during ratings period (after all, TV shows are highly differentiated and thus would have quite inelastic demand curves) they do see the demand and they’re moving to fill it.
The rest of book’s pretty cool too! Worth the read.
- Lim Yu
Zimbabwe's Economic Freefall
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Cartoon from The Economist KAL's cartoon 19/3/08 http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=8717275&story_id=10881977Although the cartoon may have exaggerated figures, the economic situation in Zimbabwe is indeed dire. Inflation is at a record high, and even with wage rises of 300 percent or more, it still cannot keep up with the rate of inflation. Fuel prices have soared so much that some complain that a day's transport to work already consumes their day's wages.
Economic indicators
Unemployment: 50%
Inflation: 60%
Poverty: 75%
Budget overspend: 25%
GDP: projected to shrink between 2 - 5%
Real income: dropped 75% in 10 years
-
as provided by BBC (
http://news.bbc.co.uk/1/hi/world/africa/978768.stm)
Since bread, sugar and cornmeal are necessities, they have an extremely inelastic demand curve. With the breakdown in domestic production with the seizure of farmland by Mugabe's government, supply is at a all-time low. Furthermore, Zimbabwe does not have the financial muscle to import enough to address the shortage.
To address the shortage and skyrocketing prices caused by the supply curve at the extreme left and a demand curve that is almost vertical, the government imposed a price ceiling that causes the price of goods to become approximately 50% of what the equilibrium price would otherwise be. Since prices for the raw materials are so high, the producers will encounter very high variable cost that is spread over a very small quantity produced. with the price ceiling, they cannot even earn enough to cover their fixed costs, causing them to have huge difficulties in maintaining their "businesses". When the government forces the suppliers to sell the resources at suppressed prices, the supply of raw materials dry up as well.
The extreme shortage in necessities has caused the black market to thrive, where the goods are sold at the black market prices and people profit. In fact, people profit not only from the necessities alone; hyperinflation has resulted in a situation where "those with good connections who can buy hard currency at the official rate and sell it to those who need it at a far higher price". - quoted from
http://news.bbc.co.uk/1/hi/business/6922441.stmBusinesses that refuse to sell the goods would be taken over by the Zimbabwe government, and the government is trying to print more money to counteract inflation. But the Zimbabwean dollar is turning out to be the modern day banana notes. 25 million Zimbabwean dollars are now worth 1 pound. Without the proper value in gold in the Federal Reserve, printing extra money just devalues the existing currency in the market.
The only way to solve this problem would be to slowly stabilise the Zimbabwe currency by injecting cash, as well as solve the underlying problem of the corrupt Mugabe government that cares more about itself than the citizens, and of course, the actual situation on the ground has to be addressed as well, with food aid and rationing, and healthcare and sanitation help.
With other humanitarian issues like the Darfur situation, it remains to be seen how much aid the international community is willing to provide to save lives.
References:
http://www.iht.com/articles/2007/02/06/news/zim.php?page=1http://www.iht.com/articles/2007/08/01/africa/zim.php?page=1as well as the links in the main text.
The first step...
To blaze the trail, we need a spark. So here is the spark:
Determinants of Demand
Determinants of Supply
Price Elasticity
That's just a start. Hope everyone can participate in this blog and make it lively, exciting, and motivating =D
PS: Please inform the team if there is/are any error(s) in the hyperlinked documents. Thankz! =D
