...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
...Profit Maximization and Wealth Maximization are two objectives of Financial Management. Financial Management takes cares for proper utilization of funds, such that it will increase company earnings. Profit Maximization refers to the profit of the firm should be increased while in Wealth Maximization objective of a firm is to maximise its wealth and the value of its shares. There is always a debate regarding which more important. Profit Maximization The basic concept behind profit maximization is to earn a large amount of profit. It is a short term objective of the company (every fiscal cycle). There is no consideration for risks and uncertainty. It acts as measure for operational efficiency of the company. Profit maximization is necessary for growth and survival of the company. Wealth Maximization The goal of wealth maximization is to improve market value of shares. The main focus is on achieving long term objectives. There is consideration for risks and uncertainty. It tends to gain a large market share. It accelerates the growth rate of a company. I cannot say which one is better. Profit is basic requirement for any company. Profit feeds oxygen in the system to take breathe and survive. As we know profit is directly proportional to the risk. Higher the profit, the higher will be the risk. Risk factor can be neglected for a short run (profit maximization) but in long run (wealth maximization) risks or uncertainty cannot be ignored. Shareholders invest in company in hope...
Words: 944 - Pages: 4
...Producers and Profit Maximization In economic theory, people play two main roles in the market. As we have just seen, they are consumers. The other main role is producers. For producers, the economic problem is to maximize profits. The key decisions are which outputs to produce, how much of each output to produce, and which inputs to use to produce the outputs. We will take these decisions one at at time. How Much Output? Let us return to Josh's lawn mowing business, and focus on the decision of how many lawns to mow each day. To make things simple, suppose he already has leased a lawnmower and a pickup truck. Also, to avoid confusing the output decision with Josh's labor-leisure choice, let us assume that all of the labor is done by two hired workers. Now, Josh has to decide how many hours for which to hire the workers, which in turn will determine how many lawns his company mows. For example, if each worker works 5 hours, then the total hours worked will be 10 and the total number of lawns mowed will be, say, 9. The key factors in Josh's decision will be worker productivity, the wage rate, and the price he can charge for mowing lawns. Suppose that Josh receives $18 for each lawn that his workers mow. Finally, suppose that his workers' lawnmowing productivity is as follows. Total Hours Worked Per Day | Lawns Mowed Per Day | Cost ($11 per hour) | Revenue ($18 per lawn) | 8 | 7 | $88 | $126 | 10 | 9 | $110 | $162 | 12 | 11 | $132 | $198 | 14 | 13 | $154 | $234...
Words: 3206 - Pages: 13
...The goal of a competitive firm is to maximize profit, which equals total revenue minus total cost. We have just discussed the firm’s revenue, and in the last chapter, we discussed the firm’s costs. We are now ready to examine how the firm maximizes profit and how that decision leads to its supply curve. A Simple Example of Profit Maximization Let’s begin our analysis of the firm’s supply decision with the example in Table 2. In the first column of the table is the number of gallons of milk the Smith Family Dairy Farm produces. The second column shows the farm’s total revenue, which is $6 times the number of gallons. The third column shows the farm’s total cost. Total cost includes fixed costs, which are $3 in this example, and variable costs, which depend on the quantity produced. The fourth column shows the farm’s profit, which is computed by subtracting total cost from total revenue. If the farm produces nothing, it has a loss of $3 (its fixed cost). If it produces 1 gallon, it has a profit of $1. If it produces 2 gallons, it has a profit of $4 and so on. Because the Smith family’s goal is to maximize profit, it chooses to produce the quantity of milk that makes profit as large as possible. In this example, profit is maximized when the farm produces 4 or 5 gallons of milk, for a profit of $7. There is another way to look at the Smith Farm’s decision: The Smiths can find the profit-maximizing quantity by comparing the marginal revenue and marginal cost from...
Words: 362 - Pages: 2
...Do NHL teams profit maximize? Explain how the authors come to this conclusion. Overview: Before we dive into the details on whether the NHL team or any sports team for that matter maximize profit, it would be worthwhile to answer 2 basic questions as put forth by the author: Would a sports fan not go to a game which he is die-hard fan of because he/she thinks the team profit maximizes? Would a sports team forego additional revenue? As with any commodity, price of an arena seat is set by supply and demand. This is why it always rings false when NHL execs try to link ticket prices to player salaries. Any sports game ticket demand in North America is influenced by a number of factors: Changes in per capita consumer income The number of consumers in a given market Changes in consumer attitudes, tastes, and/or preferences Changes in the price of a complementary product Changes in the price of a substitute product Factors Influencing the PROFIT GOAL of the FIRM What is Market Equilibrium and Why is it Relevant in this Context? The market for sports tickets, or any other product, comes into balance—into equilibrium — when the quantity of tickets that fans demand equals the quantity of tickets that teams supply. Markets are said to be in balance when: 1. Sellers are satisfied with the quantity they are selling at a certain price. AND 2. Buyers are buying all they want at that price and would not want to buy more at a higher...
Words: 1855 - Pages: 8
...Week 2 Profit Maximization Concept Application In order to maximize profit for University of Phoenix it would be advisable for the school to enroll 28 students. This would give the university a profit of $19,390 per class and be the most profit it can make with the resources given. In order to achieve maximum profit the university must use the formula MC (maximum Cost)=MR (maximum revenue) to find the correct number of students to allow per class. Looking at table 1 below we can see the MR for 28 students is $1,250 and is more than the MC of $1,192, if one more student was added then the MR would be less than the MC and the school would be loosing money. If the school were to allow for 29 students then the maximum revenue would be greater than the maximum cost and therefore would loose profit for this extra student being added. By changing the cost variable in table one by 15% we see that the maximum students per class would change to 17 students. This new number would give a profit of $9,392 for each class and would be the best use of resources for the school. This table could be adjusted again if the school found a way to lower it’s incidental costs as we can see the amount of profit go up when the variable costs were lower in table 1. It would be recommended that the Admissions Director keep the class size to 28 students if the costs are aligned with table 1 and keep a class size of 17 students if the costs are aligned with table 2. I there are any changes to the...
Words: 343 - Pages: 2
...the amount of profit for a given quantity of widgets produced. Once all profit values are determined via the TR – TC = P calculation for each increment of production, the point at which profit maximization occurs can be concluded. The largest gap between total revenue and total cost indicates the point at which profit maximization is achieved. (See Table 1) When using the marginal revenue to marginal cost approach, the ideal situation to have is when marginal revenue equals marginal cost. This is the point when the highest possible profit is being achieved. The logic behind this is that if the revenue of producing more widgets is less than the cost of producing the widgets, there is a profit to be made. If the cost of producing the widgets exceeds that of the revenue brought to the company by the selling of the widgets, then the company is losing money. Once the output quantity is established that provides the company with equal values for marginal revenue and marginal cost, the number of widgets can be adjusted accordingly. This will provide the company with a more financially successful situation. (See Table 1) B. Marginal revenue is defined as the additional revenue that is generated by increasing sales by one unit. The calculation used to determine marginal revenue is the change in total revenue divided by the change in quantity. (MR= TR/ Q) The marginal revenue in the given example decreases by $10 for each additional unit of output. This decrease in profit is due to the...
Words: 828 - Pages: 4
...Profit Maximization and Wealth Maximization An activity or decision is not useful unless it has an objective attached and this is the same goes for Financial management. Traditionally, profit maximization considered as objective of finance management and a lot of us currently look that as a short term approach which is true. It also suffered from serious limitations and is currently discarded as a main objective of finance management Profit maximization in the organization are aimed towards keeping profit as #1 priority which in other words, means that all the unprofitable ideas, projects gets rejected/put on hold vs. others. On one hand where Profit maximization can be justified on multiple ground like * The main aim of most organization is to earn profit * Profit can be suitable criteria to measure success * Efficient utilization of resources that can further maximize the profit * Profit maximization can lead to welfare of society It is also criticized on the basis of * Vague and ambiguous – As the ‘term’ profit is not defined * It ignores time value of money * Quality of benefit is ignored * Value for owners ignored * It is based on accounting policy which can be altered On the other hand, In current phase Shareholder Wealth maximization looks at the long term approach It accumulates * Market value of shares or market capitalization which is nothing but Market price per share * no of share * Reserves and surplus * Accumulated...
Words: 507 - Pages: 3
...ALTERNATIVES FOR IMPROVING PROFITS Introduction A company is considering two alternatives for improving profits: develop new products or consolidate existing products. If the company decides to develop new products, it can either develop several products rapidly or take time to develop a few products more thoroughly. If the company chooses to consolidate existing products, it can either strengthen the products to improve profits or simply reap whatever gains are attainable without investing more time and money in the products. Given The Decision tree chart attachment shows the predicted gains from each decision alternative described above. Gains depend on how the market reacts to the action taken by the company. The probability of each market reaction is shown on the decision tree. Task: Develop a response to the attached decision tree chart in which you: a) Calculate the expected value for each of the four decision branches. The company can either develop a new product rapidly or thoroughly and the returns from each decision are as follows; The total expected value as a result of each decision is found by multiplying each of the probabilities for each market condition by the corresponding expected value and summing them up (Mind Tools, 2013). Develop thoroughly: (0.4×500,000) + (0.4×25,000) + (0.2×1,000) = $ 210,200 Develop rapidly: (0.1×500,000) + (0.2×25,000) + (0.7×1,000) = $ 55,700 On the decision on consolidating the existing product, the company can...
Words: 687 - Pages: 3
...8.c. The Calculus of Profit-Maximization by a Competitive Firm Any profit-maximizing firm chooses inputs and outputs to maximize economic profits. By definition, maximization of economic profits entails maximization of the difference between the firm's total revenue and its total cost. • A firm's total revenue is defined as the quantity, Q, sold at a price, P(q): TR(q) = P(q) ∙ Q • A firm's total costs are defined as the quantity of capital, K, used multiplied by the price of capital, v, plus the quantity of labor, L, used multiplied by the price of labor (wage rate), w. TC = vK + wL • Therefore, economic profits (π), are defined as the difference between total revenue and total cost: Π(q) = TR(q) – TC(q) Maximization of this equation is found by applying the derivative with respect to q and setting equal to 0: (d π)/(dq) = (dTR)/(dq) – (dTC)/(dq) = 0 (dTR)/(dq) – (dTC)/(dq) = 0 moving things around we get (dTR)/(dq) = (dTC)/(dq) or the derivative of total revenue with respect to q is equal to the derivative of total cost with respect to q. The derivative of total revenue is marginal revenue, and the derivative of total cost is marginal cost. And thus you come to the profit maximizing equation of MR = MC In the case of a competitive firm, the firm is free to sell all the q it wants at the market price without the firm having a notable affect on the market price. This is true...
Words: 949 - Pages: 4
...EXAM IN PROFIT MAXIMIZATION AND LOSS MINIMIZATION MONSOUR A. PELMIN Problems 1. MONSOUR PELMIN SPORTS CORP. produces golf balls and can sell them for Php.15 each. The output, price, average revenue, Marginal revenue, marginal cost, average variable cost, and average total cost are shown in the table below. a. Fill in the values for average revenue and marginal revenue in the table above. b. On the axes provided below, plot the marginal revenue and the average total, average variable, and marginal costs. What is the profit-maximizing level output? How do you know? How much profit will the firm makes? Shade the area of profit on the graph. 2. Using the same data presented in the table above, suppose the price of golf balls drops to P3. Show the profit-maximizing or loss-minimizing level of output. Should this firm continue to produce at this price? How do you know? Calculate the amount of profit or loss at this price. Shade this area on the graph. 3. Suppose the price of golf balls drops to P2. What should the firm do now? How do you know? ANSWER KEYS 1. a. The average revenue and marginal revenue are the same as price. They are all P15. b. The graph shown on the following page gives the profit-maximizing output and level of profit. The Firm maximizes profit by producing 7,000 balls. Profit is (P15.00- P8.5)7,000 = P45, 500. The profit maximizing level of output occurs where MR = MC. 2. The firm’s loss is shown below as the area defined...
Words: 322 - Pages: 2
...how they are used by a company in profit maximization. By factoring, analyzing and comparing the various data on revenue and cost, a company can use a marginal analysis to determine the best direction to maximize profits. A marginal analysis is the “comparisons of marginal benefits and marginal costs, usually for decision making” (McConnell, 2011, p. 6). A. There are two methods to describe profit maximization. Further details of both methods and how each are used to determine profit maximization are as followed: 1. One method of understanding profit maximization is by using the relationship of total revenue and total cost. Total revenue is the total income that a company receives from a product or service. The price multiplied by the quantity of the product or service equates to the total revenue. Total cost is the total expense or cost to a company to produce a product or provide a service. Profit is determined by subtracting the total cost from the total revenue. Initially, as production or quantity increases, profit increases as well. There is a point, however, where the profit will maximize and then begin to diminish as the unit quantity increases. This point is where the greatest profit is realized in relation to the total revenue and total cost. This quantity is where a company would set the production level for a profit maximization plan. (McConnell, 2011, p. 167-168) 2. The other method of understanding profit maximization takes a look at the relationship...
Words: 863 - Pages: 4
...Task I EGT 1 Western Governors University November 10, 2014 A. In this monopolistic competitive market scenario, profit maximization can be arrived by working the numbers in two separate approaches. The first is Total Revenue to Total Cost and profit maximization is derived by taking the total revenue and subtracting the total cost at each quantity level. Profit maximization is at the point where the gap is the largest between TR and TC. The second approach is Marginal Revenue to Marginal Cost. In this approach profit maximization is obtained by determining where MR is equal to MC. B. In the table below, the Marginal Revenue was calculated by the change in total revenue of that resulted from selling one additional unit of output and is further defined as the change in Total Revenue divided by the change in Quantity. Marginal Revenue decreases in this table because the Marginal Costs continues to increase as shown in the MR chart below: C. In the table below, the Marginal Cost increases and is a result of the additional cost of producing of one more unit of output. The calculation is derived by taking the change in Total Cost and dividing it by the change in quantity. Since the Total Costs increases between most units, the Marginal Costs also increase. See chart below: D. Profit maximization for Company A in the table below is at the quantity of 8 units of 8 because of the higher revenue. Using the Total Revenue to Total Cost approach (hi-lighted...
Words: 580 - Pages: 3
...In the total cost revenue total cost approach to determine the profit maximizing output you will start by recognizing that profit is equal to total revenue minus total cost. The profit –maximizing output is the output at which profit reaches it maximum. In the TR TC approach the profit maximization is the quanity of output that achieves the greatest difference between TR and TC. The price of the good is set because all of the competing companies are price takers. Marginal profit is equal to marginal revenue minus marginal cost. In the marginal revenue to marginal cost approach if the marginal revenue is greater than the marginal cost then the marginal profit is positive and if the marginal revenue is less than the marginal cost then the marginal profit is negative. The profit increases when the marginal revenue is almost equal to the marginal cost. Again the profit decreases when the marginal revenue is less than the marginal cost. Again profit does not increase or decrease if the marginal revenue is equal to the marginal cost. When the production level equates the marginal revenue and the marginal cost in that case the point of profit maximization is reached. Firms compare the amount that each additional unit of output would add to the total revenue or the total cost. Marginal cost is the change in the total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good. In general terms, marginal cost at each...
Words: 472 - Pages: 2
...Profit Maximization and Corporate Social Responsibility Over the past few decades’ American companies have been obsessed with maximizing profits. This obsession has resulted in big businesses having some of the highest profit margins in history. To shareholders, this news couldn’t be better. But many times these high profit margins have come with a great price, and it is not the businesses that are paying for it. Milton Friedman’s famous article The Social Responsibility of Business is to Increase Profits, is considered by many to be the seminal piece of literature against corporate social responsibility. In his article, Friedman argues in favor of unrestricted profit maximization. While Friedman’s argument makes valid points discussing the simple nature of business in a capitalist market, he neglects to effectively address the complex issue of negative externalities that businesses impose on society. I will go on to discuss the errors in Friedman’s assumptions about the capitalist market, and explain how profit maximization can be achieved, while practicing corporate social responsibility. I will discuss more theories on why CSR is not only socially desirable; it is necessary to increase profits. Friedman’s belief that executives who practice CSR are “…unwitting puppets of intellectual forces that have been undermining the basis of a free society these past decades. (31)” He goes to explain how people have responsibilities, not businesses, and that the responsibility...
Words: 455 - Pages: 2
