Question

Following is a statistically estimated demand Curve for Amazon’s regular services (i.e, on-time delivery of products). The marginal cost of delivery/shipment of an order is given as $3.50. Amazon predicts that demand for its regular 3/5 business day service during this year’s holiday season will be in the tune of 120 million orders for the period of April- June, 2018.

            Amazon’s Daily Demand Curve for a 2-day delivery is given as: Q = 14.5 - P; where Q represents Quantity demanded in millions of orders; and P is the price Amazon charges per order.

Is Amazon currently maximizing its profit? Why or why not?

Now assume that its average total cost (variable and fixed combined) is about $5.50 per shipment, and Amazon charges 7.00 flat rate for a 2-day delivery. What will be Amazon’s projected profit for this season? (Hint: You may assume that Amazon is not charging any higher price than what is established currently).

Suppose, Amazon is not very happy with their projected profit scenario, and some of its managers are not also happy about the price that they charge to their customers. On hearing these grumblings Jeff Bezzo, Amazon’s CEO hires a team of consultants and you happen to be one of those highly paid consultants. What will be your recommendation and Why?

Answer 1

Q = 14.5 - P

P = 14.5 - Q

(i) Total revenue (TR) = P x Q = 14.5Q - Q²

Marginal revenue (MR) = dTR/dQ = 14.5 - 2Q

Profit is maximized when MR equals MC.

14.5 - 2Q = 3.5

2Q = 11

Q = 5.5 (million) for a 2-day delivery

P = 14.5 - 5.5 = $9

Projected amount for 3 months (= 90 days) = 120 million

Projected number of daily delivery = 120/90 = 1.33 million

Since profit-maximizing number of 2-day deliveries is 5.5 million, profit will not be maximized with this projection.

(ii) Projected profit ($ Million) = Q x (Price - ATC) = 120 x (7 - 5.5) = 120 x 1.5 = 180

(iii) Since profit-maximizing price (as established in part (i)) is $9, I would recommend increasing price by $2, from current price of $7 to profit-maximizing price of $9.