Profit Maximization

Contents :

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Introduction and quick definitions ................................................................... 2

How do firms maximize profit ....................................................................... 3

Is it a goal for every firm ?............................................................................ 6

IV) Conclusion and authors opinion ................................................................... 8

V) Bibliography .................................................................................................. 9

Introduction and short definitions:

At a basaic level, the goal of every firm in market economies is to maximize profit.

To understand this long and complicated process, defining the important key words seems essentiel.

> In economie, profit meens the difference between revenues and costs for a firm.

> In costs we find :

Fixed costs who are payed by the business at any level of output (wages, material...)

Variable costs who increase with the level of production.

Fixed costs appear only in the short run because some costs like wages or material (buildings...) can’t be changed in a short laps of time while they can in the long run where almost every costs are variable.

> marginal cost and revenue, depending on whether the calculus approach is taken or not, are defined as either the change in cost or revenue as each additional unit is produced, or the derivative of cost or revenue with respect to the quantity of output.

> Therfore, Profit maximazation can be defined by the process of identifying the most efficient manner of obtaining the highest rate of return from its production model.

This identification is a social science and it is crucial to say, before starting, that many theories in economie existes about profit maximization and that some of them are not very well connected to the real world.

We will see through thees pages how firms can maximize there profits and wich methods are used. Then wee will see if profit maximization is a goal for every firm and finally we will take a look to alternatives to profit maximazation.

How do firms maximize profit ?

How much should we produce ? This problem is faced by almost every company. Indeed choosing the level of output that maximizes profit is today one of the most important objectives for every business that wants to operate efficiently.

In this case we will consider that price is not an issue because firms operate in a perfect competitive market where they are are price takers.

To find the right level of output, many tools are used by firms to achieve their goal.

However, two methods seems to be used very often :

The profit maximazation by using the total approach

The profit maximazation using the marginal approach

Profit maximazation using the total approach

The total revenue minus total cost method relies on the fact that profit is equal to the difference between revenue and costs. In that case, profit will be maximized when total revenue exceeds toal costs by the greatest amount.

The best way to show how firms find their profit maximization is to draw a graph :

Source : Micreconomics by Pindyck

Finding the output that maximizes profit by the total approach isn’t the only way.

Indeed, companies can also use the marginal approach.

Profit maximization using the marginal approach

The marginal revenue minus marginal cost method is based on the fact that the total profit for a firm in a perfectly competitive market reaches its maximum point where marginal revenue is equal to marginal cost. That meens that the output level that maximizes profit is found when the change of revenue for an additional output produced is equal to the change in cost for each additional output produced.

This theorie can also be demonstrated by a graph :

Source : homemade graph

Here we can see that the optimum output is 3 because marginal revenue equals marginal cost.

Is it a goal for every firm ?

Now that we have understood the methods to maximize profit we can turn to a fundamental question : do firms really maximize profit ?

> Maximizing profit is good for stakeholders

For small businesses

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