What Is Profit Maximization?
You are free to use this image on your website, templates, etc., Please provide us with an attribution linkArticle Link to be Hyperlinked Profit maximization has been the major objective of every business and enterprise. It makes it a pillar of conventional theories of economics. Many of its assumptions have helped economic theorists formulate multiple theories related to prices and manufacturing. In addition, it aids in knowing the business behavior and the effect of price, input, and output in various market situations.
Profit Maximization ExplainedProfit maximization is a strategy of maximizing profits with lower expenditure, whereby a firm tries to equalize the marginal cost with the marginal revenue derived from producing goods and services. Economists Hall and Hitch’s theory says that every firm’s sole moto should be to generate profits. Classical economists assume the same. It is the prime target of every firm and is necessary for their progress. Companies can maximize profits by increasing the price or reducing the production cost of the goods. Firms adjust influential factors like selling price, production cost, and output levels to realize their profit goals. Theoretically, the point at which the marginal cost and marginal revenue become equal allows for the maximum gap between the MR and MC. As a result, the profit at this point is always maximum. Profit Maximization GraphProfit maximization takes into consideration many aspects. Initially, the profit becomes equal to the cost subtracted by revenue which can be plotted graphically. Then, the graph can be constructed using the revenue and cost as variables plotted against the function of output, as shown below in the supply and demand graph: You are free to use this image on your website, templates, etc., Please provide us with an attribution linkArticle Link to be Hyperlinked
Therefore, the firm can maximize profits only at the point of Q1. It begins to fall after crossing the point Q1 as MC > MR. FormulaHere is the profit maximization formula. As every firm desire to maximize its profits, its total profit is measured by the difference in the total revenue and total cost of production of goods. The total cost of production (TC) is a firm’s expenditure to produce goods and services. Marginal cost is the cost of selling one additional unit. Total revenue is the income that a firm generates after the sale of its products and services. Marginal revenue is the revenue that it generates from selling one additional unit. Hence, the simple formula of total profit is P = total revenue (TR) – total cost (TC); Or, P= TR-TC Thus, the profit is maximum when the difference between revenue and cost is the maximum. However, it happens under two conditions – first order and second order. First-orderIt mandates that input’s marginal cost (MC) equals marginal revenue (MR). mathematically: MR = MC Second-orderAccording to it, one must fulfill the first order if the marginal revenue decreases and the marginal cost increases. In other words, when marginal cost & marginal revenue are plotted on a graph against the output, the slope of marginal revenue must always be less than that of the slope of marginal cost for the application of second-order profit maximization. Profit Maximization In MonopolyThe profit maximization for monopoly depends upon PM pricing and profit maximizing quantity or level of output. It means that the marginal revenue decreases with an increase in the production of goods by an extra amount. MC > MR if the firm produces a higher quantity. In monopoly, the curve of marginal cost is upward sloping. Hence as per the profit maximization rule, the best option for profit maximization for monopoly is to produce that quantity of goods which makes the marginal cost equal to marginal revenue. That is, MR = MC. You are free to use this image on your website, templates, etc., Please provide us with an attribution linkArticle Link to be Hyperlinked Moreover, it can make higher profits if MR > MC if firms choose to lower the quantity of their output. As a result, the firm in the monopoly makes a greater profit by expanding the output quantity and charging a higher price than a competitive market. Furthermore, a monopoly firm can maximize profits by decreasing the production level if the marginal revenue becomes less for the firm when it produces many goods. Profit Maximization In Perfect CompetitionIn perfect competition, many producers create and sell homogenous goods and services in the market. Here the buyers have perfect information about the market. As a result, firms cannot influence the price of the goods and services, so they are the price taker. As demand is perfectly elastic, D = MR (Marginal Revenue} = AR (Average Revenue). So, the objective of these firms is to choose an output level to maximize profits. Hence, the sole determinant of the for-profit maximizer is point P. At point P, the revenue received on selling the only left product equals that of the marginal cost involved in producing the one final product. You are free to use this image on your website, templates, etc., Please provide us with an attribution linkArticle Link to be
Hyperlinked For maximizing profits in perfect competition, the point where marginal cost and the price becomes the same makes it possible for the condition of maximum profit to satisfy the corresponding demand curve. As a result, marginal revenue decreases in value than the marginal cost. It leads to the need to produce more goods by the firm. Therefore, the firm observes a decrease in its profit in the process. Hence, in the short term, in the graph of this concept, P becomes the equilibrium point making marginal revenue equal to marginal cost. Again, as a result, the firm under perfect competition must manufacture goods equivalent to P to maximize its profit. Here too, profit is maximum when marginal revenue = marginal cost (MR = MC) Profit Maximization vs Wealth MaximizationAlthough both the terms – profit and wealth maximization relate to the profit-making perspective of a firm, both are different in many aspects. Here are some points to clarify these concepts: The basic difference between them is the goal and duration of profit earnings.
Frequently Asked Questions (FAQs)What is profit maximization in financial management? Profit maximization in financial management means the objective of a firm to take all financial decisions to maximize the profit of a business concerning its investments and savings. It also acts as a key parameter in measuring the performance and efficiency of a firm economically. What is the profit maximization rule? The common rule for profit maximization is that firms should be able to produce enough goods and services to increase the marginal revenue. The marginal revenue should equal the marginal cost of goods and services. Therefore, the output amount of goods should be such that the price (P) charged to the customers valuing the product should equal the marginal cost (MC) that the society uses to produce one unit or product, i.e., P = MC. What is profit maximization in economics? In economics, profit maximization occurs when there is a maximum gap between total revenue (TR) and the total cost (TC). In other words, it happens when the marginal revenue of production is equal to or more than its marginal cost. (MR = MC). How to achieve profit maximization? Firms, businesses, and institutions can maximize profit by increasing sales revenue and cutting production costs. Recommended ArticlesThis has been a guide to Profit Maximization & its definition. Here we discuss profit maximization in monopoly & perfect competition, its formula & examples. You may learn more about financing from the following articles –
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