1

Chapter VII

Applications of Differential
Calculus

Profit Maximization:
• The most direct way to approach profit
maximization occurs when the firm knows the
functional relationship relating profit to the
quantity of sales.
• The general functional statement is
PR = f(Q)
where PR represents profit in dollars and Q
represents the quantity of goods sold.

1
Example:
A firm knows that the relationship between its
weekly sales Q and weekly profit PR is expressed
by the function:
PR = - 0.002Q2 + 10Q – 4000
The firm wants to determine the profit-
maximizing level of weekly sales.
A possible optimum sales point is determined by
setting the first derivative equal to 0 and solving
for Q:

PR = - 0.002Q2 + 10Q – 4000

d(PR)/dQ = - 0.004Q + 10
= 0 = - 0.004Q + 10
0.004Q = 10
Q = 2500
The second-derivative test is applied to confirm
that Q = 2500 is a maximum point on the profit
function:
d2(PR)/dQ2 = - 0.004

2
• As the second derivative is equal to a negative
constant, so a sales level of 2500 units per week
will maximize profit.
• The profit corresponding to this sales level can be
determined by substituting Q = 2500 into the
profit function:
PR = - 0.002Q2 + 10Q – 4000
= (- 0.002)(2500)2 + 10(2500) – 4000
= $8500
• Thus, the maximum profit for the firm is $8500
per week, achieved by selling 2500 units per
week. 5

Profit Maximization
Principles of Marginal Analysis:
• Business decisions often are based on marginal
analysis.
• For example, should an additional worker be
hired, or should an additional unit of output be
produced?
• These concepts can be applied to finding the
profit-maximizing level of output for a firm.
• The change in total production cost resulting from
production of an additional unit of output is the
marginal cost of that unit. 6

3
• The marginal cost of a unit of output is the value
of the first derivative of the total cost function at
that point. Total Cost

Marginal Cost
Cost

Output
Fig. 1: A total cost function and corresponding marginal cost function

Example 2:
• A typewriter manufacturer has the following total
cost function relating total cost TC to quantity sold
Q:
TC = 0.05Q3 – 0.2Q2 + 17Q + 7000
• Total cost is measured in dollars and quantity is
measured in number of typewriters.
• This is a typical total cost function with fixed costs
equal to $7000.
• The marginal cost function is equal to the first
derivative of the total cost function which is found
as follows:
MC = d(TC)/dQ = 0.15Q2 – 0.4Q + 17 8

4
• For example, at an output of 40 typewriters,
marginal cost MC is:
MC(40) = (0.15)(40)2 – (0.4)(40) + 17
240 – 16 + 17 = $241
• The above result implies that the additional cost
of 40th typewriter is $241.
• Marginal revenue MR is the change in total
revenue from selling one more unit.
• Total revenue TR is equal to the price of the
product times the number of units sold P X Q and
marginal revenue is the first derivative with
respect to Q of the total revenue expression. 9

• In some cases, firms do not have direct

knowledge of their total revenue function but
know only the expression for demand, stating
price as a function of the quantity sold, P = f(Q).
• A demand function of this form can be considered
a per unit or average revenue AR function.
• This is because
TR = P X Q
P = TR/Q = per unit or average revenue
• Knowing only the demand function of the form P
= f(Q), the total revenue function can be found
by multiplication of the demand function by Q.
10

5
 $

Fig. 3: Total revenue, average revenue, and marginal

Total revenue

Quantity
(a)

revenue functions.
Price

Average revenue

QM Quantity
Marginal revenue
(b) 11

• In Fig. 3, total revenue is a quadratic function and

both the average and marginal revenue functions
are linear with negative slope coefficients.
• Marginal revenue is equal to zero at the quantity
where total revenue is maximized, QM on Fig. 3.
Marginal Analysis and Profit Maximization:
• In attempting to obtain maximum profit, a firm
wants to maximize total, not marginal or final unit
profits.
• If the revenue gained by selling the item
(marginal revenue) exceeds the marginal cost of
its production, sale of the good will increase the
total profit. 12

6
• If the marginal cost exceeds marginal revenue for
an item, its sale will reduce total profit and the
item should not be offered for sale.
$
Marginal cost

Marginal revenue

Q*
Quantity

Fig. 4: Marginal revenue and marginal cost function.

13

• Over the relevant range of production options for

the firm, marginal revenue is a decreasing or
constant function of quantity sold and marginal
cost is an increasing function of the quantity sold.
• In Fig. 4, at points less than Q*, total profit can
be increased by the sale of additional units as the
additional revenue obtained from each unit
exceeds the additional cost of that unit.
• At quantity levels greater than Q*, in contrast,
profits are decreased for each additional unit sold.
• Total profit is maximized at the quantity point
corresponding to the equality between marginal
revenue and marginal cost. 14

7
Example 3:
For the following total cost function TC and demand
function P = f(Q), determine the quantity and price
which will maximize profit. Also, determine this
profit.
The total cost and demand functions, where Q
represents quantity of typewriters in each function,
are
TC = 0.05Q3 – 0.2Q2 + 17Q + 7000
P = 557 – 0.2Q
Solution: To solve the problem, the marginal revenue
and marginal cost functions are found and set equal
to each other. 15

TR = P X Q
= 557Q – 0.2Q2
MR = d(TR)/dQ = 557 – 0.4Q
TC = 0.05Q3 – 0.2Q2 +17Q + 7000
MC = d(TC)/dQ = 0.15Q2 – 0.4Q + 17
• The next step includes equating the two marginal
functions and solving for the profit-maximizing
quantity Q*:
MR = MC
557 – 0.4Q = 0.15Q2 – 0.4Q + 17
Q2 = 3600 16

8
 Q = Q* at the point of maximum profit
Q* = 60
• Therefore, to maximize total profit the firm should sell
60 typewriters per week.
• Selling less than 60 will lead to foregone profit and
selling more than 60 will lead to a loss being incurred
on each additional unit incurred.
• Price corresponding to the quantity point of 60 is
found by substitution of Q = 60 into the demand
function
P = 557 – 0.2Q = $545
• A price of $545 per typewriter will permit 60
typewriters to be sold and lead to maximization of
profit. 17

Total revenue TR = 557Q – 0.2Q2 = $32, 700

Total cost TC = 0.05Q3 – 0.2Q2 + 17Q + 700
= $18, 100
Profit = total revenue – total cost
= 32, 700 – 18, 100 = $14, 600
• It is determined that maximum profit per week at
a price of $545 and a quantity of 60 typewriters is
$14, 600.
• The same result can be obtained by computing a
single profit function consisting of total revenue
minus total cost and solving for price and quantity
at the maximum profit. 18

9
Class Assignment:
1. For the total cost TC and total revenue TR function, find the
corresponding marginal cost and marginal revenue function.
a. TC = 0.03Q3 + 5Q2 – 12Q + 400
b. TR = Q3 + 0.2Q2 + 6Q
2. The total revenue TR and total cost TC functions for a
certain brand of desk-top computer are as follows:
TR = - 3Q2 + 216Q
TC = 0.08Q3 – 3Q2 + 120Q + 200
where Q represents the number of desk-top computers.
a. Develop a profit function for the computer.
b. Find the quantity of computers corresponding to the
maximum profit point. 19

Cost Analysis
Finding a Firm’s Shut-Down Price:
• In contrast to fixed costs such as facility rent, variable
costs such as labor and utilities are those elements of
production costs which change as output changes.
• Knowledge of the dollar value of minimum average
(per unit) variable cost is useful to a firm.
• If product price (average revenue) does not meet or
exceed average variable cost, the firm should stop
production.
• This does not imply that the firm goes out of business
because the fixed costs (i.e., rent) must continue to
be paid. 20

10
• If price does not meet or exceed the average
variable cost and production continues, the firm
loses not only its fixed costs but also a part of the
variable cost on every unit produced.
• When product price falls below average variable
cost, the firm will minimize its losses by ceasing
production.
• The price corresponding to minimum average
variable cost specifies the lowest possible price
that the firm can face in the market and
economically continue production.
• Frequently, this price is referred to as the firm’s
shut-down price. 21

Price
Average Variable Cost

“Shut-Down” P
1
Price Average revenue

Q1

Quantity

Fig. 5: The “Shut-Down” price for a firm.

• Fig. 5 shows a quadratic average variable cost

curve.
22

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• At its minimum point (Q1, P1), a demand (average
revenue) function touches the average variable
cost curve.
• The price point P1 corresponds to the lowest price
a firm will accept for its product and continue
production of the good.
Example 4:
The following is the total cost function TC for voltage
regulators used by various industries. Here, total
cost is measured in dollars, and it is a function of
the quantity of voltage regulators produced Q:
Total cost TC = Q3 – 24Q2 + 230Q + 500
23

• The constant term 500 represents fixed cost and

is not relevant in the present analysis.
• The remainder of the function expresses total
variable cost TVC:
TVC = Q3 – 24Q2 + 230Q
Average variable cost AVC is a per unit measure
of TVC:
AVC = TVC/Q = Q2 – 24Q + 230
• To minimize AVC, the first derivative is computed
and set equal to zero:
d(AVC)/dQ = 2Q – 24 = 0
Q = 12 24

12
• The quantity point of 12 is a minimum point as the second
derivative is equal to +2.
• At a quantity of 12 voltage regulators, the firm will reach
minimum average cost.
• The dollar value of AVC at this quantity is found by
substituting Q = 12 into the AVC function, and this is
comparable to the lowest acceptable price to the firm. The
price is $86.
AVC (12) = (12)2 – (24)(12) + 230 = $86
Shut-down price = $86
• The firm should cease production if the voltage regulators is
less than $86.
• If the price is less than $86, the firm will minimize its losses
by stopping production and meeting only its fixed-cost
obligations. 25

Diminishing Marginal Returns of Inputs:

• The use of inputs (labor, machinery,
management, etc.) often is associated with the
principles of diminishing marginal returns.
• It indicates that the additional output because of
the use of additional units of a resource increases
up to a point thereafter declines.
• The decline in marginal returns occurs because
inefficiencies are encountered as resource use
expands.
• At the point where the marginal returns of an
input stop increasing and start to decrease,
marginal returns are at their maximum point. 26

13
• When marginal returns from inputs are increasing,
the marginal cost of output is decreasing.
• Decreasing marginal returns from inputs are
associated with an increasing marginal cost of output.
• Consequently, the point of change between
increasing and decreasing marginal returns and
decreasing and increasing marginal cost is of
importance to the operation of a firm.
• If total cost TC is a function of the quantity produced
Q, and the quantity produced Q is a function of a
resource input R, then:
Total cost function: TC = f(Q)
Production function: Q = f(R) 27

• A production function is a quantitative relationship

between an input factor or factors and the final
output of a good or service.
• Marginal cost MC is the first derivative with
respect to quantity of the total cost function.
MC = f’(Q)
• The following explains the relationship between
decreasing and increasing marginal returns to
inputs and increasing and decreasing marginal
cost:
1. If dQ/dR > 0 then d(MC)/dQ < 0
(increasing marginal returns to inputs) 28

14
 2. If dQ/dR < 0 then d(MC)/dQ > 0
(decreasing marginal returns to inputs)
3. If dQ/dR = 0 then d(MC)/dQ = 0
Example 5:
A manufacturer of electric hot-water heaters knows
the total cost function for the production process
is
1. TC = 0.1Q3 – 12Q2 + 800Q + 2100
where TC represents total cost in dollars and Q
represents the quantity of electric hot-water
heaters.
29

Find the quantity of hot-water heaters corresponding

to the point of minimum marginal cost.
To determine this quantity, the marginal cost
function is derived as follows:
2. MC = d(TC)/dQ = 0.3Q2 – 24Q + 800
To find a stationary point on this function, the first
derivative is set equal to zero and the result is solved
for Q. This is shown in steps 3, 4, and 5.
3. d(MC)/dQ = 0.6Q – 24
4. d(MC)/dQ = 0 = 0.6Q – 24
5. 0.6Q = 24
Q = 40 30

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 6. d2(MC)/dQ2 = 0.6
Step 6 demonstrates that the point Q = 40
represents minimum marginal cost since the
second derivative is positive at that point.
The marginal cost at Q = 40 is
7. MC = 0.3Q2 – 24Q + 800
MC(40) = 0.3(40)2 – 24(Q) + 800 = 320
• The point Q = 40 with a marginal cost of $320
represents minimum marginal cost.
• At this point, returns from use of input are at their
highest level.
31

• At outputs higher than 40, diminishing marginal

returns from use of input, and a corresponding
increase in the marginal cost of output, take
effect.
• Thus, Q = 40 represents an output of maximum
marginal returns from use of input and minimum
marginal cost of producing electric hot-water
heaters.

32

16
 Marginal Productivity Analysis
• The basic marginal productivity measurement is
referred to as the marginal physical product of a
resource use.
• Marginal physical product is measured in physical
output, not dollars.
• It is an expression of the additional output
resulting from the application of an additional unit
of input, such as one more laborer or one more
hour of machine time.
• It is found by evaluating the instantaneous rate of
change (first derivative) of the production function
at a particular level of input use. 33

• The first derivative of the production function with

respect to one input is the marginal physical
product of that input.
• The marginal physical product of a resource
multiplied by the market value of the output
produced by that resource yields a dollar figure
representing the monetary value of the input to
the firm.
• The concept of marginal physical product is an
important component of models concerned with
wages, machinery usage, and other questions of
resource allocation.

34

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Example 6:
For a steel manufacturer using a particular process,
output per day in tons of steel Y is expressed as a
function of labor-hours X1 and machine-hours X2:
Y = X11/4 X23/4
Find the expression for the marginal physical product
of each input. Also, find the marginal physical
product of each at an application of 16 labor-hours
and 81 machine-hours.
Solution:
Marginal Physical Product of Labor:
1. MPP(X1) = 0Y/0X1 = X11/4[0(X23/4)/0X1] +
X23/4[0(X11/4)/0X1] 35

0Y/0X1 = X11/4(0) + X23/4 (1/4) X1-3/4

= (¼)X1-3/4X23/4
Marginal Physical Product of Machinery:
2. MPP(X2) = 0Y/0X2 = X11/4[0(X23/4)/0X2] +
X23/4[0(X11/4)/0X2]
0Y/0X2 = X11/4(3/4)X2-1/4 + X23/4(0)
= (3/4)X11/4X2-1/4
1. MPP(X1) at X1 = 16 and X2 = 81:
MPP(X1) = (¼)X1-3/4X23/4 = 27/32 of a ton of steel
2. MPP(X2) at X1 = 16 and X2 = 81:
MPP(X2) = (¾)X11/4X2-1/4 = ½ of a ton of steel 36

18
• Thus, for 16 labor-hours and 81 machine-hours,
the marginal physical product of labor is 27/32
ton of steel and the marginal physical product of
machinery is ½ ton of steel.
• Each amount represents the incremental change
in steel production in response to a 1-unit change
in the respective input at the stated points.
• For example, if labor-hours are increased from 16
to 17 and machinery is held constant at 81 hours
per day, steel production will increase by 27/32
ton of steel per day.

37

Class Assignments:
1. For each total cost function TC, find the average
variable cost function and shut-down price.
a. TC = 0.6Q3 – 24Q2 + 410Q +1500
b. TC = 0.004Q3 – Q2 + 80Q + 1600
2. For each marginal cost function MC, find the
quantity Q corresponding to minimum marginal
cost. Find marginal cost at this point and show
that the point is a minimum. State the importance
of this point to the analysis of a firm’s production
process.
a. MC = 0.1Q2 – 6Q + 170
b. MC = 3Q2 – 180Q + 2900 38

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3. For the function given below, find the marginal
physical product of X1 at X1 = 8 and X2 = 4 and
marginal physical product of X2 at X1 = 5 and X2 = 4.
Y = 0.03X13 – 0.4X1X2 + 0.6X21/2

39

Elasticity of Demand
• In business, “elasticity” is a term of general
application used to express the change in one
variable in response to a given change in a second
variable.
• Some of the most common elasticity measurements
refer to changes in the demand for a good or service
caused by various other factors, and this group is
referred to as elasticity of demand measurements.
Examples:
• Income Elasticity of Demand – It is the percentage
change in the quantity demanded of a good in
response to a percentage change in consumer
income. 40

20
• Cross-Price Elasticity of Demand – It is the
percentage change in the quantity demanded of one
good in response to a percentage change in the price
of a second good.
Price Elasticity of Demand:
• It evaluates the percentage change in the quantity
demanded of a good in response to a percentage
change in the price of the good.
Price elasticity of demand for X =
Percentage change in the quantity demanded of X
Percentage change in the price of X

41

• The price elasticity of demand can be computed

at a single point on the demand function or over a
range of the function, yielding the point price
elasticity of demand and the arc price elasticity of
demand, respectively.
• Since differential calculus is used to determine the
rate of change of a function at a point, so point
price elasticity of demand will be discussed here.
Point Price Elasticity of Demand –
Price elasticity of demand for X =
(ΔQX/Qx)/(ΔPX/Px) = (ΔQX/ΔPX)(PX/QX)
where QX and PX refer to the original quantity and
price points, respectively. 42

21
• In the above expression, ΔQX/ΔPX can be stated
dQ/dP because ΔPX approaches the limit of zero at
a point.
Point price elasticity of demand (εp) = (dQ/dP)(P/Q)
• When demand function is of the form P = f(Q),
dQ/dP is obtained by the inverse function rule,
i.e., dQ/dP = 1/(dP/dQ), to determine the point
price elasticity of demand (εp).
εp = {1/(dP/dQ)}(P/Q)
Example 7:
The demand, or average revenue, function for
television is 43

P = 450 – 0.4Q
where P is expressed in dollars and Q represents the
number of televisions demanded by consumers.
A firm wants to determine the point price
elasticity of demand at a quantity of 120 televisions.
Solution:
First: The price corresponding to Q = 120 is
P = 450 – 0.4Q = 450 – 0.4(120) = $402
Therefore, the coordinates of the relevant point on
the demand curve are Q = 120, P = $402
Second: The rate of change at the above point must
44

22
be determined by use of the inverse function rule:
P = 450 – 0.4Q
dP/dQ = - 0.4
dQ/dP = 1/(dP/dQ) = - 2.5
Third: The point price elasticity of demand εp is
computed at Q = 120:
εp = (dQ/dP)(P/Q) = (- 2.5)(402/120) = - 8.375
• At this point, the point price elasticity of demand
indicates that a 1 percent change in price (either an
increase or decrease) from $402 will result in an
8.375 percent change in the quantity demanded in
a direction opposite to the price change. 45

• As a demand curve specifies an indirect

relationship between price and quantity
demanded, the sign on the point price elasticity of
demand is always negative.
• By considering the absolute value of the point
price elasticity of demand, |εp|, the categories can
be described as shown below:
1. If |εp| < 1, demand at that point is inelastic
with respect to price.
2. If |εp| > 1, demand at that point is elastic with
respect to price.
3. If |εp| = 1, demand at that point is unitary with
respect to price. 46

23
• Knowledge of the price elasticity of demand is
useful to a firm in computing the “sensitivity” of
sales to price changes.
• Necessities such as bread or household electricity
exhibit inelastic demand; thus, their price
sensitivity is low.
• Luxury items like jewelry tend to have a high price
sensitivity (elastic demand).
• Therefore, it is important for firms to understand
a product’s elasticity of demand when developing
pricing and marketing strategies.

47

Other Elasticity Measurements:

• For any dependent variable Y and independent
variable X, a general statement of the elasticity of
Y with respect to X at a point of Y is stated as
follows.
• For Y = f(X), the percentage change in Y in
response to a percentage change in X at (x, y) is
expressed as
(dY/dX)(x/y)
where x and y represent the coordinates of the
point under consideration.

48

24
• At times, it is necessary to find the elasticity
associating the dependent variable with one
independent variable in a function with several
independent variables.
• If Y is the dependent variable and Xi is the
particular independent variable used in the
elasticity figure, the elasticity of Y with respect to
Xi at the point (xi, y) is stated as follows:
Percentage change in Y in response to a
percentage change in Xi at (xi, y) is:
(0Y/0Xi)(xi/y)
where xi represents the value of the variable Xi at
the point under consideration. 49

• For the computation of the above, all other Xi must

be held constant at specific stated values.
Example 8:
The weekly sales of home computers in a city is
expressed by the following function:
Qc = 30 – 0.02P + 2.1I
Where Qc = weekly sales of home computers
P = average retail price of home computers
I = average family income in thousands
A firm wants to determine the income elasticity of
demand at an average family income of $20, 000 (I
= 20) and average retail price of $600 (P = 600).
50

25
Solution:
• The firm wants to determine the percentage
change in computer sales in response to a
percentage change in income at an income level
of $20,000 holding price constant at $600.
1. Qc = 30 – 0.02P + 2.1I
2. Find Qc at I = 20 and P = 600
Qc = 30 – 0.02P + 2.1I
= 30 – (0.02)(600) + (2.1)(20)
= 30 – 12 + 42 = 60

51

3. Find (∂Qc/∂I)I/Qc:
(∂Qc/∂I)(I/Qc) = (2.1)(20/60) = 42/60 = +0.7
4. Income elasticity of demand at an income of
$20,000, holding price constant at $600, is equal
to +0.7.
• This shows that a 1 percent increase (decrease) in
family income will increase (decrease) home
computer sales by 0.7 percent. This relation is
valid if the average price is held constant at $600.
Example:
Find the point price elasticity of demand at a price
$600 (P = 600) and an income level of $20,000
52

26
per year (I = 20) for the following demand function
for home computers Qc:
1. Qc = 30 – 0.02P + 2.1I
= 30 – (0.02)(600) + (2.1)(20) = 60
2. Point price elasticity of demand is
(∂Qc/∂P)(P/Qc) = (- 0.02)(600/60) = -12/60 = - 0.2
• This indicates that at a constant income level of
$20,000 and constant price of $600, the demand
is inelastic. Thus, the percentage change in sales
will not be as great as the percentage change in
price at this point of the function.
53

Class Assignment:
Find the point price elasticity of demand at each
specified point:
1. P = 32 – 0.004Q at Q = 5000
2. P = 70 – 0.02Q at Q = 800

54

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