Central role of economic profit in business strategy

Economics -- Profits, Costs, and Economies of Scale

In principle, the theater owner wants to increase revenue by raising prices without imposing such a high price increase that the possible resulting reduction in patronage will have the opposite effect (Mankiw, 2008). Based on the current ticket price, the total income is $6,000 per night. The theater owner could, in theory, double his ticket prices and suffer the loss of half his customers without affecting his revenue. In theory, this would increase his profit margin because the overhead costs (i.e. supplies, cleanup, wear and tear on property, etc.) of entertaining half as many customers is considerably lower than that of entertaining twice as many. However, in comparison with the nominal savings in this regard, there is a much greater risk that doubling ticket prices would reduce profits in the long-term because it will likely result in the gradual loss of existing customers to the competition (including competition from alternative recreational options if not other theaters) and the reduction in future new customers (Mankiw, 2008).

Unlike the situation with retail consumer goods whose production costs can be readily amortized by reduction in cost-per-unit production, the theater does not produce tangible goods. Therefore, the marginal cost of entertaining each additional audience member is so small that it becomes negligible. By increasing ticket prices only a dollar or two, the theater could likely maintain most of its clientele and avoid reducing its appeal to new customers, thereby increasing profits. Diseconomies would not develop unless or until the theater decided to expand its facilities or to purchase additional movies based on the expectation that a full house could be maintained and then experienced insufficient additional patronage to offset those additional costs (McConnell, Brue, & Flynn, 2008).