...Chapter 9 PROFIT MAXIMIZATION Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. 1 The Nature of Firms • A firm is an association of individuals who have organized themselves for the purpose of turning inputs into outputs • Different individuals will provide different types of inputs – the nature of the contractual relationship between the providers of inputs to a firm may be quite complicated 2 Contractual Relationships • Some contracts between providers of inputs may be explicit – may specify hours, work details, or compensation • Other arrangements will be more implicit in nature – decision-making authority or sharing of tasks 3 Modeling Firms’ Behavior • Most economists treat the firm as a single decision-making unit – the decisions are made by a single dictatorial manager who rationally pursues some goal • usually profit-maximization 4 Profit Maximization • A profit-maximizing firm chooses both its inputs and its outputs with the sole goal of achieving maximum economic profits – seeks to maximize the difference between total revenue and total economic costs 5 Profit Maximization • If firms are strictly profit maximizers, they will make decisions in a “marginal” way – examine the marginal profit obtainable from producing one more unit of hiring one additional laborer 6 Output Choice • Total revenue for a firm is given by R(q) = p(q)q • In the production of q, certain economic...
Words: 2497 - Pages: 10
...services that cannot be generated cost-effectively. Through systematic pricing policies and strategies, companies can reap greater profits and increase or defend their market shares. FACTORS INVOLVED IN PRICING POLICY The pricing of the product involves consideration of the following factors: (i) Cost Data in Pricing: Cost data occupy an important place in the price setting processes. There are different types of costs incurred in the production and marketing of the product. There are production costs, promotional expenses like advertising or personal selling as well as taxation, etc. They may necessitate an upward fixing of price. For example, the prices of petrol and gas are rising due to rise in the cost of raw materials, such as crude transportation, refining, etc. If costs go up, price rise can be quite justified. However, their relevance to the pricing decision must neither be underestimated nor exaggerated. For setting prices apart from costs, a number of other factors have to be taken into consideration. They are demand and competition. Costs are of two types: fixed costs and variable costs. In the short period, that is, the period in which a firm wants to establish itself, the firm may not cover the fixed costs but it must cover the variable cost. But in the long run, all costs must be covered. If the entire costs are not covered the producer stops production. Subsequently, the supply is reduced which, in turn, may lead to higher...
Words: 1429 - Pages: 6
...Chapter 8: Profit Maximization and Competitive Supply CHAPTER 8 PROFIT MAXIMIZATION AND COMPETITIVE SUPPLY TEACHING NOTES This chapter begins by explaining what we mean by a competitive market and why it makes sense to assume that firms try to maximize profit. The chapter then covers the choice of optimal output in the short run, thereby revealing the underlying structure of short-run supply curves, the choice of output in the long run and long-run competitive equilibrium. Along the way, the concepts of producer surplus and economic rent are introduced, and the chapter ends with development of the long-run industry supply curve. Section 8.1 identifies the three basic assumptions of perfect competition and section 8.2 discusses the assumption of profit maximization as the goal of the firm. Students often find some of these assumptions to be unrealistic and/or very restrictive, so it is important to acknowledge that the world is more complex, but remind them that our goal is prediction. Although the world does not work quite as simply as the model of perfect competition suggests, the model predicts quite well even when some of the assumptions hold loosely at best. To put perfect competition in perspective, it can be helpful to give a brief overview of monopoly, oligopoly, and monopolistic competition before or after presenting the assumptions of perfect competition. Restrict this discussion to identifying the number of firms in the industry, product differentiation...
Words: 8601 - Pages: 35
...Homework #3 April 7, 2011 1) The profit maximization rule for determining the most efficient output level is considered through marginal revenue, and marginal cost. The point at which profit is being maximized is when the revenue gained from selling one additional unit is equal to the cost of producing the unit. At this point, the firm is receiving an average rate of return at the highest output level possible. For example, a shoe producer pays $25 to produce one shoe and can sell the shoe for $50. At this output level the marginal profit is $25 and the profit maximization rule would dictate an increase in output. Inversely, had it cost the show maker $60 to make one additional shoe and could only sell the shoe for $50 the profit maximization rule would dictate a decrease in output. Following profit, marginal revenue would be -$10 and the maximization rule always leads to maximum profit when marginal revenue is equal to marginal cost, the highest output level attainable without losing money to produce the product. 2) STEPS 1. Begin at initial long-run equilibrium 2. Income elasticity is -1.3 and consumers income decreases 3. Quantity demanded decreases 4. Price is bid downward and the firm is faced with a new marginal revenue 5. If the consumers’ income does not recover over time the LRAC curve will fall downward 6. In response to the market, the firm will decrease output until marginal revenue equals marginal cost 7. π=Q(P-LRAC)<0...
Words: 377 - Pages: 2
...Chapter 1,2,3 – Answers to Assigned End of the Chapter Questions 1-1. Shareholder (owner) wealth maximization is the most widely cited business goal. The justification for shareholder wealth maximization is that managers are hired by the owners (shareholders) and serve as their agents. In addition, the well-being of the managers is closely tied to the wealth of the shareholders. In perfect competition, shareholder wealth maximizing behavior is necessary just to survive. 1-2. a. Wealth maximization for a single-period decision is measured by economic profit which is the excess of earnings or cash flow over that which could have been earned on investments of similar risk. b. Wealth maximization for a multi-period decision is measured by discounting the expected future economic profits (which is the excess of earnings or cash flow for each period over that which could have been earned on investments of similar risk for that period) back to present. 1-4. Present value is either a single future amount discounted back to present or the sum of a number of future amounts discounted back to present. Net present value is the sum of the present value and the initial outlay or outlays necessary to produce the future amount(s). 1-5. A capital investment is an outlay that is expected to result in benefits extending more than one year into the future. Capital budgeting is the process of selecting capital investments. 1-6. Steps in capital budgeting process: ...
Words: 1219 - Pages: 5
...Product pricing is the price fixed upon a product by producers or suppliers to achieve sales in order to gain profit. There are a number of factors affecting product pricing in the UK. The first factor is the structure of the market. Oligopoly is a type of market that can be seen in the UK, for example, electricity and gas supply industry in Britain. Oligopoly is a market structure where there are few enough firms to enable barriers to be erected against the entry of new firms. Firms will come together (collude) and try to maximise their joint profits either by a formal agreement or tacit. However, formal agreements are illegal in the UK and it may also be unstable to due incentive for individual member firms to ‘cheat’. Non-collusive oligopoly is when firms do not collude and work independently for their own businesses. Firms are, however, interdependent when it comes to pricing policy. There is a variety of models to explain non-collusive oligopoly. The first model is the Cournot model where one firm changes its output, assuming their rival firm will keep their output fixed. There is also the Bertrand model which is when one firm changes its output in assumption that their rival firm will keep their prices fixed. Lastly, the kinked demand theory shows how price reduction of a firm is followed by others but not an increase in price. Figure 1 shows the kinked demand diagram but it does not show how price P1 and quantity Q1 came to exist. Figure 1 Another type of market...
Words: 1160 - Pages: 5
...1.0 Introduction Profit maximization has to do with usage of limited resource in achieving optimal output hence it involves the prudent rationing of scare resource to production sectors that have the ability to yield the most returns all things being equal, However in the market concept the intention of the producer and supplier is to meet the needs of the customer or buyer hence that informs the producer where he should channel the available limited resources; because his or her inability to know the buyers interest directly or indirectly affects his profit margin therefore the need to study the power of the customer with regards to purchasing power and the need to fish out their interest at any given time in the production process. A thorough search has come up with the following factors as those that have the ability to influence a business windfall or profit margin in firms .Substainability of industry profit is a yardstick through which an organization can fulfil it aspirations. It can be daunting for business owners even to consider sustainability when they have other things to think about the day to day operations of the business. To be effective , sustainability needs to be worked into a business core strategy. This means starting with the executive discussions at the top level and ensuring that priorities trickle down to the lower level. Profit is the life blood of every sustainable organization to operate in the competitive environment. The following outline the signal...
Words: 2115 - Pages: 9
...fixed and the firm faces a multitude of competitors, all producing perfect substitutes. In these circumstances, the purely competitive firm may sell all that it wishes at the equilibrium price, but it can sell nothing for even so little as one cent higher. Monopoly power also depends upon elasticity of the demand curve. If the demand curve is less elastic the monopolist has a greater degree of control. As the demand curve becomes more flexible or flatter the monopolist’s control starts declining. Question # 6 * There are many factors involving in the price change in pure competitive and monopoly firms. The producer can face different price from both firms. Competitive firm have many competitors so that they cannot increase or decrease price as they want but in monopoly they can. The producer always interested to get higher price so monopoly firm can pay producer more to get the products. Economics of scale may be such as to ensure that one large firm can produce at lower cost than a multitude of small firms. This is certainly the case with most public utilities. And in such industries as basic steel making and car manufacturing, pure competition would involve a very high cost. On the other hand, monopolies may...
Words: 905 - Pages: 4
...Model This module is composed of two units. In the first one, Profit Maximization and Competitive Supply, we present a short but very useful introduction to mathematical concepts, namely the derivative technique, used in the economic field. Many examples will be given to clarify the concepts studied. Then, we will use this technique to calculate marginal cost, marginal revenue, and optimal output that will be produced by a competitive firm. . In Unit 2, The Analysis of Competitive Markets, we will study the welfare effects of a government policy by using consumer and producer surplus. Unit 1 Introduction In this Unit, we will learn a new mathematical technique. By using this technique, we calculate marginal cost, marginal revenue, and the optimal output the competitive firm will produce. Learning objectives Upon completion of this unit you should be able to: • define the derivative of basic functions; • use derivatives to calculate marginal revenue and marginal cost; and • use derivatives to calculate a competitive firm's supply function. Assigned reading/viewing/listening Microeconomics, Eighth Edition textbook and study guide – Chapters 8. How to proceed 1. Read the PowerPoint slides of Chapter 8 to get a brief idea about the chapter. 2. Read chapter 8 carefully. 3. Solve the provided problems on the textbook's companion website. 4. Solve exercises at the end of chapter 8 in your textbook. Key words and examples Derivation...
Words: 1694 - Pages: 7
...right over a particular drug that extends for a period of 20 years, creating barriers to entry where other firms cannot enter the market. The existence of high barriers to entry prevents firms from entering the market even in the long-run. Therefore, it is possible for the monopolist to avoid competition and continue making positive economic profits in the long-run. If congress remove patent protection for life saving drugs in order to reduce the cost of the Medicare and Medicaid system, there will be many implications in the short-run and long-run that will effect both the pharmaceutical companies and consumers both positive and negatively. Monopolies can maintain super-normal profits in the long run. As with all firms, profits are maximized when MC = MR. The level of profit depends upon the degree of competition in the market, which for a pure monopoly is zero. Profit maximization, MC = MR Monopolies can maintain super-normal profits in the long run. As with all firms, profits are maximized when MC = MR. The level of profit depends upon the degree of competition in the market, which for a pure monopoly is zero. Profit maximization, MC = MR If patents are removed in the short-run, consumers will experience the benefits of the life-saving drugs available at...
Words: 1579 - Pages: 7
...Professor Owen R. Phillips University of Wyoming Ross Hall 124 COURSE SYLLABUS FOR INTERMEDIATE MICROECONOMICS 4020 Course Description and Prerequisites Economics is broadly defined as a way of thinking about problems of allocation. This course entails the use of intermediate microeconomic theory in the analysis of problems facing decision-makers, not only in business, but also in government and other nonprofit organizations. Intermediate microeconomic theory can be described as the theory of choice. It has application to all decision problems. Specific theoretic tools are developed and applied to real world settings in order to illustrate optimal decision guidelines. The prerequisites for this course are a beginning economics class in microeconomics and a basic understanding of algebra and geometry. Required Textbook Required: Pindyck, Robert S. and Rubinfeld, Daniel L., Microeconomics, Third Edition, Prentice-Hall, 1995, ISBN 0-02-395900-2. Determining Your Grade During the course there are two “midterm” examinations. At the end of the course there is a comprehensive final examination; in the final exam there is some emphasis on the material following the second examination. All of the exams consist of multiple choice questions. Questions will be of a problem-solving nature much like those assigned in the homework. The homework questions are excellent preparation for the examinations. Answers to many of these questions are worked in the...
Words: 3518 - Pages: 15
...Supply………………………………29 3.1. Long-Run Equilibrium Conditions…………………………………..29 3.2. Long-Run Industry Supply Curve…………………………………...33 3.3. Perfect Competition Market Efficiency……………………………...36 CHAPTER IV Practical analysis……………………………………………………..41 CONCLUSIONS……………………………………………………………………...45 LITERATURE………………………………………………………………………...47 APPENDIX…………………………………………………………………………...49 INTRODUCTION The issue of supply in the perfect competition conditions is a rather complex topic. It comprises of many crucial points that I will try to identify and explain. Some of them will be caused by the perfect competitive conditions’ regulations of the general processes of the supply formation, profit maximization, equilibrium achieving and others, dictated by the characteristics of the perfect competition itself, such as a large number of small firms, identical products sold by all firms, perfect resource mobility or the freedom of entry into and exit out of the industry, and perfect knowledge. It is obvious that when dealing with perfect competition it is market rules instead of the individual or group ones striving to hold the grasp over the economic situation, as it would occur in monopoly, oligopoly or monopolistic competition. Even the British historian Lord Acton once observed,...
Words: 12140 - Pages: 49
...In this analysis, automobile market in Turkey will be evaluated in terms of the market structure. In the analysis, automobile producers which sell their products in Turkey (car brands in Turkey) will be taken into consideration. While making the analysis, the basic structural and behavioral assumptions of the market structures will be incorporated which are number of sellers, cost conditions, number of buyers, demand conditions, objective function, strategic variable, expectation of rivals’ reactions. Structural Assumptions: Number of Sellers: There are about more than 30 automobile companies operating in Turkey which are engaged in directly or indirectly (via distributors) selling automobiles in Turkey. Regarding the structural assumption of seller number, it can be concluded that there are few number of sellers in the market. The reason behind the few number of sellers is the substantial barriers to entry into the market, which is due to the high investment amount needed to start production. Cost Conditions: Given the scale of productions as constant, the companies face with diminishing returns which results in an increase in marginal costs in the short run. Number of buyers: Mentioned production companies generally sell the products to either individual consumers or to the distributors of the brands. That’s, it can obviously said that there are many buyers in the market. Demand conditions: In the market, there are different segments of cars that are sold...
Words: 687 - Pages: 3
...Equilibrium: When the market demand and the market supplied are equal then the market is said to be at equilibrium. That means that the equilibrium price will be equal to the demand and supply price. * Budget Line: The budget line explains the product of two that are affordable in certain amount of consumer’s income. 1. When income increases the budget line shifts to right. 2. When income decreases the budget line shifts to left. If the allotted price on the vertical axis increases the budget line makes a parallel shift downwards. If price on the vertical axis decreases then the budget line make a shift upwards. * Producer Surplus: The total revenue that producers obtain from a good and the price paid. This is the difference between the minimum supply price that sellers are willing to afford and the price they actually receive is known as producer surplus. * Price ceiling: It is a legal maximum price that is imposed on the market below the price that otherwise would be in equilibrium. It is placed because of keeping the price at low to consumer that they can be able to purchase. * Price floor: The legal minimum price that is actually imposed on market on the actual price. It is imposed to keep the prices high as per government * Market Demand: The total demand of person on which he or she is willing to buy a good. It is found by...
Words: 1010 - Pages: 5
...------------------------------------------------- Top of Form Powered by JRank Bottom of Form Reference for Business Encyclopedia of Business, 2nd ed. Reference for Business » Encyclopedia of Business, 2nd ed. » Man-Mix » Managerial Economics MANAGERIAL ECONOMICS Ads by Google 1 year diploma courses - Info on Courses, Scholarships & Admissions from IDP Experts. -india.idp.com/18001022233 SWOT Analysis Tool - Get a free 30 day trial of Mindjet the leading Mindmapping Tool! -www.Mindjet.com online gcp courses - Online, Classroom & Blended Courses Certification Programs & More! -www.cfpie.com CAT Scholarships-T.I.M.E. - Must for all cat and mba aspirants Register Now-Upto 100% scholarships - www.time4education.com/ttse Photo by: nyul Ads by Google MBA - Supply Chain Mgmt. 100% Online backed by Textbooks Academic support,E-Library.Join Now utsglobal.edu.in Rapid eLearning Train your employees with Rapid eLearning, cut your business costs www.niidtech.com MBA Distance Education Online 1 Yr MBA @ 29000. Approved from AIMA India & IAD UK. Enrol Now www.iibmindia.in Papermaking Technology Download white papers on new papermaking machines and processes www.risiinfo.com/whitepapers Decisions made by managers are crucial to the success or failure of a business. Roles played by business managers are becoming increasingly more challenging as complexity in the business world grows. Business decisions are increasingly dependent...
Words: 7613 - Pages: 31
