Cost Revenue and Profit Maximization
Cost, revenue, and profit maximization refers to the process by which a firm determines the level of output that will result in the highest possible profit. This involves analyzing the costs of production, the revenue generated from selling goods or services, and finding the output level that maximizes the difference between total revenue and total cost. It is a fundamental concept in business decision-making.
8 Key excerpts on "Cost Revenue and Profit Maximization"
eBook - ePubEconomics for Investment Decision Makers
Micro, Macro, and International Economics
- Christopher D. Piros, Jerald E. Pinto(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
...A business increases profit through greater sales as long as per-unit revenue exceeds per-unit cost on the next unit of output sold. Profit maximization takes place at the point where the last individual output unit breaks even. Beyond this point, total profit decreases because the per-unit cost is higher than the per-unit revenue from successive output units. A third approach compares the revenue generated by each resource unit with the cost of that unit. Profit contribution occurs when the revenue from an input unit exceeds its cost. The point of profit maximization is reached when resource units no longer contribute to profit. All three approaches yield the same profit-maximizing quantity of output. (These approaches will be explained in greater detail later.) Because profit is the difference between revenue and cost, an understanding of profit maximization requires that we examine both of those components. Revenue comes from the demand for the firm’s products, and cost comes from the acquisition and utilization of the firm’s inputs in the production of those products. 3.1.1. Total, Average, and Marginal Revenue This section briefly examines demand and revenue in preparation for addressing cost. Unless the firm is a pure monopolist (i.e., the only seller in its market), there is a difference between market demand and the demand facing an individual firm. The next chapter devotes much more time to understanding the various competitive environments (perfect competition, monopolistic competition, oligopoly, and monopoly), known as market structure. To keep the analysis simple at this point, we note that competition could be either perfect or imperfect. In perfect competition, the individual firm has virtually no impact on market price, because it is assumed to be a very small seller among a very large number of firms selling essentially identical products. Such a firm is called a price taker...
eBook - ePub- Rob Dransfield(Author)
- 2013(Publication Date)
- Routledge(Publisher)
...Analysis of costs and revenues helps us to find out how much businesses should produce, and what prices they should charge, in order to maximize their profits. The profit maximizing point of a business is the point at which there is the greatest difference between total revenues (TR) and total costs (TC). Figure 4.9 shows this. Figure 4.9 The profit maximising output Please note that total revenue is represented by a straight line assuming that the business charges a standard price as it increases output. Total cost increases more than proportionally to the increase in output at first (because of diminishing returns). Total cost then rises less than proportionally to the increase in output because of increasing returns. Beyond the most efficient point total cost will again start to rise more than proportionately to output because of diminishing returns. The profit maximizing output is the point at which there is the greatest vertical difference between cost and revenue. Reflective question Will producers always want to maximize profit? If the answer is no, what are the alternatives and why might they choose one of these alternatives? Marginal cost and marginal revenue Economists use marginal cost and marginal revenue analysis as a tool to identify the profit maximizing point of a firm. The logic behind this is simple. The margin is the extra unit of something – for example, the additional cost or the additional revenue from producing one more unit. When the marginal cost of producing an extra good is less than the marginal revenue of the good, the producer or seller will make additional revenue from selling that unit. For example, a producer knows that the 1,000th unit of production will cost 50 pence to produce but will yield 60 pence worth of revenue. So it makes sense to make that unit. The producer knows that the 1,100th unit will cost 59 pence to produce but will yield 60 pence worth of revenue...
eBook - ePubEconomics
A Foundation Course for the Built Environment
- J.E. Manser(Author)
- 2003(Publication Date)
- Routledge(Publisher)
...9 Profit maximization PREVIEW Can a firm in perfect compition choose how much to produce and what price to charge? Is a monopoly free to decide its output and prices? Is it possible to have a monopoly and at the same time to be in competion with others? Must all coast be covered in the short run? Should the coast of building the Channel Tunnel be reflected in the fares charged for using it? Traditional theory of the firm is based on profit maximization. Profit is defined simply as the difference between revenue and costs. Revenue depends on both the volume of sales and the unit price. Since prices are affected by the level of competition, we must analyse how the firm behaves in different market situations. COSTS AND OUTPUT Costs are not as straightforward as they might appear. What is the cost of travelling from Southampton to Birmingham by car? It depends on what counts as a cost for the purpose of that trip. Obviously fuel costs count and perhaps an allowance for wear and tear, but do you include a share of the road tax and insurance? What about the cost of buying the car, should a part of that be included? Is this a single journey or a regular trip? It may not be possible even to identify the relevant costs without more information. The first step is to break down costs into different groups. Some costs are fixed in the short run. These costs, such as insurance and depreciation, remain at a constant level regardless of changes in output. They are also called overheads or prime costs. Other costs are variable, or direct costs, so called because they are directly linked to output, e.g. labour and materials. Variable costs increase with production, but not necessarily in direct proportion to it. To determine the point of maximum profit we focus on the margin because this is where adjustments take place...
eBook - ePub- Andrew Barkley, Paul W. Barkley(Authors)
- 2016(Publication Date)
- Routledge(Publisher)
...This is a simplification of the real world, since there may be producers who have other goals, such as a nice lifestyle, a clean environment, world peace, political power, or to pay employees more than the market wage rate. Although there are many producers who may not do everything in their power to maximize profits, this profit maximization goal is a good first approximation. Why? Because any business owner who does not pay attention to potential profits is unlikely to remain in business for long in a market economy. Figure 2.3 Grade as a function of study time Profits, denoted by the symbol π (the Greek letter pi), have special meaning and importance in economics. Here, profits are defined as total revenue (TR) minus total costs (TC): (2.11) π = TR – TC. Profits [r] = total revenue minus total costs: π = TR – TC. The value of product sold minus the cost of producing that output. Total revenue is simply the dollars earned from the sale of a good. Let the quantity of a good sold be given by Q units, and the price of the good by P dollars per unit (USD/unit). Then, the total revenue earned by the producing firm is equal to TR = P*Q. The units for total revenue are in dollars, since P is in USD/unit and Q is in lbs, bushels, dozens, or some other appropriate measure; when P is multiplied by Q, the units cancel and TR is in USD. Total costs represent the total costs of production of the good, and are also in dollar units. Producers of goods and services alter their production and marketing activities in a never-ending effort to maximize profits. The ability of business firms to make changes in how they produce and sell goods depends on the product that they produce. If the product is corn, major adjustments are possible at least once each year, with a small number of changes occurring throughout the year...
eBook - ePub- Andrew Barkley, Paul W. Barkley(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
...Chapter 4 Profit maximization Photo 4.1 Profit maximization Source: Thoma/Shutterstock Abstract This chapter explores the profit-maximizing level of inputs and outputs for a firm in a competitive industry. It defines and explains perfect competition and clarifies the economic approach of comparing benefits and costs in decision-making. Graphs explain the optimal level of inputs and outputs. This chapter emphasizes the intuitive appeal of profit maximization and the rationale for using profits and losses to help determine a firm’s break-even and shutdown points. It is a comprehensive treatment of the heart of microeconomics. 4.0 Introduction The lessons regarding good economic decisions continue in this chapter. The materials presented here are important in economic decision-making and provide a comprehensive way of looking at the world. The “economic way of thinking” is based on comparing the benefits and costs of every human activity. It applies to purchasing a new pickup truck, attending college, or studying late. The marginal analysis used here is also an important tool of microeconomics that focuses attention on the advantages and disadvantages of each decision. • Marginal Analysis = comparing the benefits and costs of a decision incrementally, one unit at a time. The following paragraphs show that marginal analysis, or the economic approach to decision-making, applies to a great number of decisions, choices, and issues. 4.1 Perfect competition To determine the profit-maximizing levels of inputs and outputs, we will use the concepts introduced in the preceding chapters and an additional piece of information: the price of the product (P Y). This price is the market price received by producers when they sell their output (Y). The units of the output price are in dollars per unit of output (USD/Y). The term “output price” requires additional assumptions (simplifications) about the structure of the market in which the firm operates...
eBook - ePub- Lorenzo Garbo, Dorene Isenberg, Nicholas Reksten(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
...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? 4.4 A survey of market structures 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. Let’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 in which the firm operates...
eBook - ePubMedia Economics
Applying Economics to New and Traditional Media
- Colin Hoskins, Stuart M. McFadyen, Adam Finn(Authors)
- 2004(Publication Date)
- SAGE Publications, Inc(Publisher)
...That is because the price selected will determine the quantity that can be sold, or the output selected will determine the price at which this volume can be sold. Usually, the active decision firms make is with respect to price. 6.2 Identifying the Profit Maximizing Output and Price: Marginal Analysis Now that we understand how revenue varies with output and price, if we combine this knowledge with that from chapter 5 on how costs vary with output, we will be able to explore the level of output and price that maximizes profit. In Table 6.2, we have added cost information assumed for the Forthright Company to the revenues reported in Table 6.1. Given the assumed level of total variable costs (TVC) in row six and total fixed costs (TFC) of $1 in row seven, total cost (TC = TFC + TVC), average variable cost (AVC = TVC/Q) and marginal cost (MC = ΔTVC or ΔTC for a one-unit change in output) are calculated. Note that as there is a fixed cost, we are examining a short-run example. Also, as marginal cost increases throughout, this is a case in which the Law of Diminishing Returns sets in immediately. The most straightforward way to determine the profit maximizing output and price is to calculate the profit directly as total revenue (TR) minus total cost (TC). The results of this calculation are shown in the last row. Profits are maximized at $2 by producing either 1 or 2 units, consistent with a price of $4 or $3, respectively. This is shown graphically in Figure 6.2...
eBook - ePubIntermediate Microeconomics
A Tool-Building Approach
- Samiran Banerjee(Author)
- 2014(Publication Date)
- Routledge(Publisher)
...In particular, there are no exclusive technology or patents that confer an advantage to any firm. The best technology and business practices are commonly known. Thus any variation in costs across producers are generally small and mainly due to managerial efficiencies or differing opportunity costs of the entrepreneurs. Finally, there is complete mobility of firms. Existing firms may leave the industry in the medium to long run if they find that to be advantageous, or new entrepreneurs may enter the market. We assume that there are no substantial costs or difficulties in making entry or exit decisions. 9.1 Defining Profits The profit of a firm, π, is defined as the difference between total revenue (TR) which is the earnings from sales, and total cost (TC): Since TR = p × q where q units of output are sold at a per-unit price of p, and TC = c (q) is the firm’s cost function, the firm’s profit π is a function of the output q, and may be written as We will assume that the cost function includes a normal profit margin which is the smallest compensation that an entrepreneur needs in order to remain in business, i.e., the entrepreneur’s opportunity cost. With this included in the TC, it follows that if π = 0, then the revenues earned are just enough to pay for the operating expenses (the cost of variable inputs such as labor and raw materials), the overhead (cost of fixed inputs, such as salaries of managers, the cost of hosting the firm’s website, the firm’s property taxes, etc.) as well as the entrepreneur’s compensation...
