Question

Laura is a gourmet chef who runs a small catering business in a competitive industry. Laura specializes in making wedding cakes. Laura sells 20 wedding cakes per month. Her monthly total revenue is $5,000. The marginal cost of making a wedding cake is $300. In order to maximize profits, Laura should:_________.
a. make more than 20 wedding cakes per month.
b. make fewer than 20 wedding cakes per month.
c. continue to make 20 wedding cakes per month.
d. we do not have enough information to answer the question.

Answer 1

Answer:

b. make fewer than 20 wedding cakes per month.  

Explanation

Laura sells 20 wedding cakes per month.

Her monthly total revenue is $5,000.

Marginal Revenue = $5000 / 20 cakes = $250

The marginal cost of making a wedding cake is $300.

In order to maximize profits, Laura should make fewer than 20 wedding cakes per month.  

The reason is that Laura's marginal cost is higher than her marginal revenue implying that she is spending more on each item than she is gaining.

By reducing one unit of output she will be gaining more revenue.

Profit Maximization Rule Definition  states that if a firm chooses to maximize its profits, it must choose that level of output where Marginal Cost (MC) is equal to Marginal Revenue (MR) and the Marginal Cost curve is rising. i.e. it must produce at a level where MC = MR.

Hence Laura has to make fewer cakes