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).

Answer 1

Q = 14.5 - P, therefore

P = 14.5 - Q

(i) Profit is maximized when Marginal revenue (MR) equals MC.

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

MR = dTR/dQ = 14.5 - 2Q

Equating MR and MC,

14.5 - 2Q = 3.5

2Q = 11

Q = 11/2 = 5.5 million orders per day

Total number of orders in 3 month (= 90 day) period (millions) = 5.5 x 90 = 495 million

Therefore, projected order volume of 120 million being less than profit-maximizing order volume of 495 million, profit is not maximized.

(ii) Projected profit ($ Million) = Projected volume x (Price - Average total cost)

= 120 x (7 - 5.5) = 120 x 1.5

= 180