Profit Maximization

Only available on StudyMode
  • Download(s) : 435
  • Published : December 7, 2012
Open Document
Text Preview
Profit Maximization
Marginal revenue is the change in revenue which comes from the sale of an additional unit of output. The relationship with total revenue is that total revenue is used in the formula to calculate marginal revenue. A company can calculate marginal revenue by dividing the change in total revenue with the change in output quantity. Because of demand, as production quantity increases the revenue per unit will decrease.

On the other hand, marginal cost is the change in the total cost that comes from the production of one more unit of good. To calculate marginal cost, a company would divide the change in total cost by the quantity produced in that period. Keep in mind, that at a certain level of production, it might cost more to produce an additional unit than the previous.

Profit is the financial return that companies and entrepreneurs strive to achieve. It can be calculated by total sales less total costs. A loss occurs when costs are greater than the sales. Most companies have to deal with losses in the first few years of operation.

The goal of every firm is to maximize profit. Since total revenue and total cost are both a function of quantity, the goal is to find the quantity of production that will maximize profit. This would occur at a quantity where total revenue less total cost is the greatest. One can also look at profit maximization as a relationship between marginal revenue and marginal cost. Profit maximization occurs at a quantity where marginal revenue equals marginal cost, that is, marginal profit is zero. At this quantity, the company is maxed out on how many units it can produce and sell before it starts losing money.

If marginal revenue is greater than marginal cost, then a profit-maximizing firm will produce that extra unit because it will give an increase in total profit. Even though the profit per unit sold is diminishing, the company is still making money. Of course, there are other factors that go into...
tracking img