Profit maximation

• Profit maximization


  The main goal of the company is to maximize profit (microeconomic approach) or to maximize its value (financial approach)
• Other possible business goals of the company

  • Achieving market share at a certain level
  • Market dominance in specific areas
  • Obtaining profit at a specified level
• Economic profit


  Total revenue - all economic costs
• Accounting profit


  Total revenue - all accounting costs
• Accounting costs include only current or historical explicit costs, but not implicit costs (opportunity costs of resources supplied by the owner)</b>
• The difference between economic cost and accounting cost is the opportunity cost of resources supplied by the owner of the company
• The opportunity cost of these owner-supplied resources is called normal profit
• If the owners of a firm obtain economic profits


  They are receiving a rate of return on the use of their resources that exceeds that which can be received in their next-best use
• If a company is receiving economic losses (negative economic profits)

  The owners are receiving less income than could be received if their resources were employed in an alternative use
• If economic profits are equal zero, then owners receive a payment equal to their opportunity costs, what could be received in their next-best alternative, and there is no incentive for firms to either enter or leave this industry
• Total profit calculation


  1. TP=TR-TC

  2. TR=P*Q

  3. TC=FC+VC

  4. TP=P*Q-FC-VC

  5. TP=P*Q-ATC*Q

  6. TP=(P-ATC)*Q
• Break even-point


  The point at which cost or expenses and revenue are equal, there is no net loss or gain
• Marginal revenue


  The additional revenue received from the sale of an additional unit of output
• If marginal revenue is positive, then total revenue is increasing. If the marginal revenue is negative, the total revenue decreases. Total revenue reaches a maximum where marginal revenue is 0.
• At maximum of TR, MR equals 0
• Break-even point calculation


  Can be calculated either in units of product (number of produced items) or currency units (e.g. dollars, PLN etc.)
• Break-even point for linear demand function

  Q=-aP+b, where a, b - parameters of demand function
• Break-even point calculation example

  Caltulate the profitable range of output for the following data: AVC= 1, FC = 10, Q= -P +10
• When output rises, both total revenue (till it takes maximum value) and total costs increase
• Profits increase when output increases if total revenue rises by more than total costs


  Profits decrease when output rises if total costs rise by more than total revenue
• Marginal revenue (MR)


  The additional revenue resulting from the sale of an additional unit of output
• Marginal cost (MC)


  The additional cost resulting from the sale of an additional unit of output
• If marginal revenue exceeds marginal cost


  The production of an additional unit of output adds more to revenue than to costs, so the firm is expected to increase its level of production to increase its profits
• If marginal cost exceeds marginal revenue


  The production of the last unit of output costs more than the additional revenue generated by the sale of this unit, so firms can increase their profits by producing less
• A profit-maximizing firm will produce more output when MR > MC and less output when MR < MC
• If MR = MC, the firm has no incentive to produce either more or less output. The firm's profits are maximized at the level of output at which MR = MC.
• Marginal profit


  The profit earned by a firm when one additional unit is produced and sold
• Marginal profit analysis may be helpful because it can determine whether to expand or contract production or even to stop the production, if a shutdown point is obtained
• Marginal profit calculation


  Marginal profit = MR - MC
• Perfect competition


  • A very large number of buyers and sellers, easy entry, a standardized (homogenous) product, each seller is price taker
• Monopolistic competition


  • A large number of firms, the product is differentiated (each firm produces a similar, but not identical, product), almost no entry barriers, the company is a price maker that faces a downward sloping demand curve
• Oligopoly


  • A small number of firms produce most output, there are significant barriers to entry, mutual interdependence exists (each company realizes that its profitability depends on the actions and reactions of competitors)
• Monopoly


  • A single seller producing a product with no close substitutes, effective entry barriers, the firm is a price maker
• Most output is produced and sold in oligopoly and monopolistically competitive industries
• Bibliography


  • http://www.oswego.edu/~kane/eco101.htm
  • Czarny B. „Podstawy ekonomii", PWE, 2002
  • https://en.wikipedia.org/wiki/Break-even
  • https://www.investopedia.com/terms/m/marginal-profit.asp
  • https://www.aqusagtechnologies.com/want-to-maximize-profit-at-the-minimum-cost-read-on/
• Discussion topics


  • What are the main goals of the company? Compare microeconomic and financial approach.
  • Describe total revenue and marginal revenue. Give examples.
  • Describe the golden rule. If the marginal cost is higher than marginal revenue what would you do.
  • If the economic profit is equal zero - what does it mean for the company?
  • Why the marginal revenue could take negative values?
  • Give the example of break-even point calculation.
  • Characterize the perfect competition market. Give examples.
  • Characterize the monopolistic competition market. Give examples.
  • Characterize the oligopolistic market. Give examples.
  • Characterize the monopolistic market. Give examples.