Economics
Profit Maximization
Profit maximization is the process by which a company aims to achieve the highest possible level of profit. This involves determining the optimal level of output and pricing to maximize revenue while minimizing costs. In practice, firms often use various strategies such as cost-cutting, pricing optimization, and production efficiency to pursue profit maximization.
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10 Key excerpts on "Profit Maximization"
eBook - PDF- Rhona C. Free(Author)
- 2010(Publication Date)
- SAGE Publications, Inc(Publisher)
11 Profit Maximization MICHAEL E. BRADLEY University of Maryland, Baltimore County M ainstream microeconomics generally assumes that firms seek to maximize economic profit, the differ-ence between total revenue and total economic costs. This, like many others in economics, is an unrealistically simple picture of the way that firms actually make decisions. Economists make many such unrealistic assumptions that abstract from and simplify the real world to explain economic phenomena and generate empirically testable predictions. Assuming that firms act rationally to maximize profit is critical for analyzing and explaining the firm's choices of outputs of goods and factor inputs. The theory of produc-tion and cost collapses without assuming profit maximiza-tion or some other maximizing assumption. For example, a production function determines a single output from each bundle of factor inputs, but technology and resource quality define only the maximum output that can be produced with a given bundle of inputs, and there is nothing to prevent firms from producing less than the maximum output. If we assume that the firm seeks to maximize profit, it follows that it will produce only the maximum output from any given bundle of inputs or that it will use the combination of inputs that produces a given output at the lowest cost. Profit Maximization: The General Case Assumptions Because profit is the difference between the revenue and cost generated by factor inputs and outputs, the profit-maximizing model assumes given production, revenue, and cost functions. These, in turn, are defined only for given resource quality, technology, product prices, and factor prices.
eBook - ePubMicroeconomic Foundations I
Choice and Competitive Markets
- David M. Kreps(Author)
- 2012(Publication Date)
- Princeton University Press(Publisher)
It is impossible to do justice to this literature here, without expanding this chapter unreasonably and, in any case, some of the answers require pieces of economics that we haven’t yet studied. So I’ll plead simply that Profit Maximization is a modeling assumption, one with which economists are comfortable not as a law of nature but as an approximation to reality. Having said that, three specific points are worth making, albeit briefly. • Profit Maximization as an objective function for firms is a lot more specific than utility maximization for consumers. When we assume that a consumer maximizes her utility, we leave it up to the consumer how she feels about apples versus oranges. But, once prices are given, the trade-offs facing a firm are fixed if the firm maximizes profit. (On the other hand, the choice set of a consumer is fixed once prices are fixed and the consumer’s income is given. For firms, the production-possibility set Z gives a lot of latitude to the modeler.) • Accounting earnings or income is not economic profit. Accounting income does not include any return on capital equipment. • The arguments in the literature for Profit Maximization when there is a division between managers and owners of the firm turn to some extent on a contention that managers act on behalf of the firm’s owners, who prefer Profit Maximization. Why managers do this is usually the issue being studied in the literature. But it is worth noting that the assertion that owners prefer Profit Maximization is very bound up in the assumption that the firm has no impact on prices
eBook - PDF- William Boyes, Michael Melvin(Authors)
- 2015(Publication Date)
- Cengage Learning EMEA(Publisher)
top: ª Carsten Reisinger/Shutterstock CHAPTER 23 Profit Maximization Preview You start a business. To get it off the ground, you use your own money and perhaps the money of friends and relatives. Then you put in many hours to get the business on a suc-cessful footing. If the business provides enough to match what you could have earned working for someone else (taking into account the joy of owning your own business), you consider it a success. Similarly, when you purchase the stock of a publicly traded company, you are expecting that the firm will pay you more than you could have gotten using that money in another way. If it does, then the investment is a success. We measure the success of a business and an investment in terms of profit. FUNDAMENTAL QUESTIONS 1. How do firms decide how much to supply? 2. What is a market structure? 3. What is the difference between economic profit and accounting profit? 4. What is the role of economic profit in allocating resources? Ariel Skelley/Getty Images 509 Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 23-1 Profit Maximization Profit is total revenue less total costs. Total revenue is the quantity of goods and services sold multiplied by the price at which they are sold, PQ . So, profit ¼ PQ – cost of land, labor, and capital. 23-1a Calculation of Total Profit Consider Table 1, in which column 1 is total output ( Q ), column 2 is price ( P ), column 3 is total revenue ( TR ), and total cost ( TC ) is listed in column 4. Profit, the difference between total revenue and total cost, is listed in column 5.
eBook - PDFManagerial Economics
The Analysis of Business Decisions
- Stephen Hill(Author)
- 2016(Publication Date)
- Red Globe Press(Publisher)
In particular, the equalisation of marginal cost and marginal revenue calls for precise measurements that are unlikely to be available. The business world is one of considerable uncertainty, characterised by discarded plans and unfulfilled ex-pectations. In these circumstances, precise economic calculus be-comes operationally meaningless. As a result, economists have attempted to redefine the objectives of the firm. Such redefinition has followed three broad paths: (i) Attempts to resurrect the profit objective by placing profit in the context of an uncertain world. Profits and objectives 53 (ii) The replacement of profit with some other objectives, or group of objectives, that can be maximised in place of profit. (iii) Abandoning the principle of maximising any objective, and consider instead the organisational context of the firm, nor-mally expressed in terms of the satisfaction of some group of performance targets. The rest of this chapter will consider each of these possible avenues in turn. The descriptions that follow are not intended to be a comprehensive guide to business motivation, but rather to impart a flavour of what may be called 'managerial' approaches to the firm. Profit related objectives According to this viewpoint, the true objective of the firm is something closely related to profit. Often the objective is tied to uncertainty, such as survival , security or the maintenance of liquid assets . Each of these objectives is complementary to profit, in that the maximisation of profit may ensure the attainment of that objective. The behaviour of the firm can then be modelled as if the firm was maximising profit. Moreover, the informational problem inherent in the maximisa-tion of profit is then an error of 'misplaced concreteness'.
eBook - PDF- Paul Cashian(Author)
- 2017(Publication Date)
- Red Globe Press(Publisher)
Equation 2.3 shows the firm’s objective function, which is to maximise profits given the constraints discussed above. The firm needs to maximise the difference between revenue and costs – but can only do this by varying its output level Q as the price is fixed by the market. ...................................... The Economists’ Firm 27 Max = rP Q − cC Q w.r.t Q (2.3) From this, we thus arrive at the familiar profit maximisation condition that marginal revenue, the revenue from the last unit produced, should equal marginal cost, the cost incurred in producing the last unit. MAX P = rP Q − cC Q w.r.t Q ⇒ (2.4) ⇒ R/Q − C/Q = 0 ⇒ R/Q = C/Q MR = MC In effect, all firms pick a level of output Q that maximises Equation 2.4. This profit maximising condition can also be represented graphically as shown in Figure 2.4. The explanation for the shape of the various curves forms the central part of any introductory microeconomics course on production theory, and readers are referred to any of the numerous texts for an explanation (for example, Sloman and Sutcliffe, 2003). The profit maximising output of q * is shown as where the Quantity Revenue, cost C = c ( C , Q ) R = r ( P , Q ) q * δ C / δ Q δ R / δ Q Quantity Revenue, cost q * Figure 2.4 The production process (graphical representation) ........................................................
eBook - ePub- John H Hoag(Author)
- 2012(Publication Date)
- WSPC(Publisher)
What difference would there be between firms acting to minimize cost compared to maximizing profit? Firms should try to minimize cost regardless of the output produced. Profit Maximization is a strategy to choose the level of output to produce. Here is the citation for this study: Loren Tauer, “Do New York Dairy Farmers Maximize Profits or Minimize Costs?”, American Journal of Agricultural Economics, Vol. 77, No. 2, May, 1995, pp. 421–429. Section Summary: In this section, we have seen that from the marginal curves alone, we cannot determine the amount of profit the firm makes. To find profit, we need some added curves: the average curves. In addition, we have developed the shutdown condition, and illustrated it as well. In the next section, we will combine the Profit Maximization proposition and the shutdown condition to find the firm’s supply curve. 5.6 The Competitive Firm’s Supply In this section, we combine the Profit Maximization proposition and the shutdown condition to obtain the competitive firm’s supply curve. This will provide the construction of the second big concept in economics: supply. We start with a definition of the concept we are seeking. Definition 5.10: The firm’s supply curve is a relationship between output and dollars per unit of output showing the number of units a firm would choose to produce and sell at each price with input prices and technology not changing. The definition is about the choices that the firm makes. We know that the firm acts to maximize profit. Hence, we can now look at quantities the firm would choose to produce at each price. Of course we know that at some prices the firm will decide to shut down, so we will have to take that into consideration as well. Consider Figure 5.8. Figure 5.8 In the left graph, we have the firm choosing the profit-maximizing output at a variety of prices. We bring the prices and the associated quantities to the graph on the right to find supply
eBook - PDFMicroeconomics
Theory and Applications
- Edgar K. Browning, Mark A. Zupan(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
Consider firms in the hospitality industry, such as Hilton and Marriott. Suppose some of them virtually ignore profit, either through ignorance, negligence, bad luck or intention. Their cost of labor is too high, they fail to mini- mize waste in their food service, they neglect training for the staff who serve customers, and so forth. Other firms, whether through superior management, close attention to costs, or the good luck of being closest to a newly enlarged convention center, produce the right type of lodging in the appropriate quantity and in the least costly way. What will happen when these firms compete for customers? Clearly, the firms that come closer to maximizing profit will make money and prosper; the others will suffer losses. In general, in competitive markets, firms that do not approximate profit-maximizing behavior fail; the survivors will be the firms that, intentionally or not, make the appropriate profit-maximizing decisions. This observa- tion is called the survivor principle and provides a practical defense for the assumption of Profit Maximization. While it goes without saying that firms must pay close attention to profit, some deviation from single-minded Profit Maximization may still occur. Most economists, however, believe that the Profit Maximization assumption provides a close enough approximation to be use- ful in analyzing many problems, and it has become the standard assumption regarding the firm’s behavior.
eBook - PDF- Martha L. Olney(Author)
- 2015(Publication Date)
- Wiley(Publisher)
Profit 87 doing anything else. An economic profit below zero (a loss) is bad. It means the owner is doing worse in this business than he could doing something else. How Much Profit The firm’s total profit equals its total revenue minus total costs. Total revenue is price times quantity. Total cost is average total cost times quantity. So total profit is Total profit = (price − average total cost) × quantity Total profit is equal to the area of the rectangle whose base is the profit-maximizing quantity and whose height is the difference between the price and the average total cost at that quantity. If price is greater than average total cost as in Figure 6.5a, profit is positive. Economists say: The firm is earning an abnormal profit. (a) (b) Area = Profit $ Area = Loss $ MC MC MR ATC ATC MR Quantity of output p 1 q 1 Quantity of output q 2 p 2 ATC of q 1 ATC of q 3 = p 3 ATC of q 1 Profit = 0 MC MR ATC (c) Quantity of output q 3 $ p 3 Figure 6.5 How much profit? In Figure 6.5a, the price is above the average total cost at the profit-maximizing quantity, and so the firm earns an abnormal profit. In Figure 6.5b, the price is below the average total cost at the profit-maximizing quantity, and so the firm incurs a loss. In Figure 6.5c, the price equals the average total cost at the profit-maximizing quantity, and so the firm’s profit is zero, a normal profit. 88 Chapter 6 Perfectly Competitive Firms If price is less than average total cost as in Figure 6.5b, profit is negative. Economists say: The firm is earning an economic loss. If price just equals average total cost as in Figure 6.5c, profit is zero. Economists say: The firm is earning normal profit. Why would a firm stay in business if its profit was zero? Remember that the profit we are measuring here is economic profit.
eBook - ePub- Lorenzo Garbo, Dorene Isenberg, Nicholas Reksten(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
every input gets fully paid at the current rates or wages. You may wonder: why bother to own this firm if the firm is just breaking even? Well, if the owner of the firm owns all or part of the capital stock (machinery, space, and so on), then the owner will receive a normal return from the investment in that capital stock. And if the owner actually works in the firm, the owner will also receive the appropriate compensation for her/his labor. The firm just “makes enough” to cover all the costs without losing and without gaining anything extra (no economic losses, no economic profits).Take a moment to reflect on these different concepts of profits. What does it mean to a firm’s operation if it is not making a normal profit? Now, how would you describe the other profit situations?
In order to analyze the decision-making process that leads to the firm’s maximization of profits, we need to become very well acquainted with the determinants of Total Revenues and Total Costs.4.4A survey of market structuresLet’s begin our analysis with total revenues. We have already encountered this concept when we talked about the price elasticity of demand in Chapter 3 : total revenues consist of the “money” the firm obtains by selling its output, i.e., TR = P * Q, where “P” is the price of each unit of output, and “Q” is the firm’s output. Thus, if the firm is a hair salon that produced 200 haircuts (Q = 200) sold at $30 each (P = $30), the total revenues of the hair salon turns out to be $6,000.A key question we need to look at is: if the firm changes the quantity produced, does the firm affect/change the price at which that quantity produced can be sold? Another way to ask this question is: does the price at which the firm can sell its product depend on how many units of the product the firm brings to the market? What is your intuition about this? If Apple doubles the number of iPhones supplied in the market, do you think that the price of iPhones will be affected? If a peasant with a small number of cows doubles the amount of milk supplied in the overall market of milk, do you think that the price of milk would be affected?You may have already come to the realization that the answer to these questions depends on how large the firm is in relationship to the market
eBook - PDF- Kumar, K Nirmal Ravi(Authors)
- 2021(Publication Date)
- Daya Publishing House(Publisher)
At what level of output, the firm can maximize the profits. Answer Considering the given profit function: π = 2Y-0.1Y 2 -3.6, substitute each level of output and compute the profit. Output (Y)(000) Profit (Rs’000) 0 –3.6 2 0.0 4 2.8 6 4.8 8 6.0 10 6.4 12 6.0 14 4.8 16 2.8 18 0.0 20 –3.6 The above table guide to draw the profit function and it all looks inverted U shaped curve as in Figure 8.17 . Thus, a firm’s profit function shows its maximal profits as a function of the output that the firm produces. The profit function shows the relationship between the firm’s decision variable (output, Y) and its objective (profits) (π). That is why, we can call profit function as the Objective function. Profit is maximized at the quantity Y* ( Figure 8.17 ) and is lower at all other quantities. The curvature of the profit function is consistent with a negative second derivative and results in This ebook is exclusively for this university only. Cannot be resold/distributed. Y* being a quantity of maximum profit. From the Figure 8.17 , it is clear that, the slope of the profit function is zero at its maximum point. So, the first derivative of the profit function with respect to output will be zero at output (Y*). But, the problem is, how do we know we have a maximum instead of a minimum? So, go for second derivative of profit function and it must be less than zero i.e. (d 2 π/dY 2 )<0 to have profit maximum (See Example 8.4). From the profit function, we can also compute Marginal Profit, which is nothing but the slope of the tangent to the profit function. So, (Δπ/ΔY) gives the marginal profit. That is, marginal profit, (Δπ/ΔY)=Marginal revenue - Marginal cost. Figure 8.17 : Profit Function Curve. Example 8.4 Given the cost function TC(Y) = 500 + 3Y + 0.01Y 2 and the demand function P(Y) = 10, find the number of units to be produced in order to have maximum profit. Answer This ebook is exclusively for this university only. Cannot be resold/distributed.
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