Profit Maximisation Business Objectives Mr OGrady Profit Maximisation

Profit Maximisation Business Objectives Mr O’Grady

Profit Maximisation Definition: Where businesses produce the quantity of output and charge the corresponding price so that they achieve the greatest positive difference between total revenue and total cost. Unless otherwise stated, this is the assumed objective of firms Condition: Profit max occurs where MC = MR Recap: Recall that the equation for marginal revenue is MR = ∆TR/∆Q , therefore MR is the gradient function of the TR curve. The same is true for Marginal cost. MC = ∆T/∆Q, Therefore MC is the gradient function of TC C/R TC Diagrammatic proof: In a total revenue diagram therefore, profits are maximised where the gap between total revenue and total cost is at its greatest. This occurs at the output were the gradients (i. e. slopes) of both curves are equal at point QPM, so MR = MC Before this point, TR and TC are still diverging, so profits are not yet maximised at Q 1 – i. e. can still increase profits by raising output. Also prior, MR > MC therefore the marginal unit is adding to profit. After this point, TR and TC are converging, so raising output to Q 2 will only reduce profits. After, MR < MC therefore the marginal unit is reducing profit Q 1 QPM Q 2 TR Output

Intuitively: 1. If Q < Qmax, then MR > MC. This implies that marginal profit is positive. Thus, by producing and selling one more unit the firm will earn generate additional supernormal profit; increasing output will increase profit. 2. If Q > Qmax, then MR < MC. In this case, the cost of producing an extra unit is greater than the additional revenue gained from selling it. Therefore, the marginal profit is negative, reducing the total profit; decreasing output will now increase total profit. 3. When Q = Qmax, profit is maximised. This is because you have produced all the possible units of output that have a positive marginal profit – producing them will increase total profit. Furthermore, you produce no units with negative marginal profit. Consequently, total profit must be maximised here. On a theory of the firm Diagram: QPM occurs where MR = MC Price PPM is charged for each unit The average cost to make each unit is CPM The supernormal profit area (green rectangle) is maximised C/R MC AC p. PM c. PM D = AR QPM MR Quantity

Revenue Maximisation Business Objectives Mr O’Grady

Revenue Maximisation Definition: Revenue maximisation occurs Rev. where firms sell at a price that generates the largest revenue possible Firms may pursue revenue max instead of profit max in order to increase their market share/deter rivals from entering Condition: revenue max occurs where MR = 0 Analysis: If marginal revenue is positive, an extra unit sold must add to total revenue and revenue maximisation will not have been reached. Only when marginal revenue is zero will total revenue have been maximised. Stopping short of this quantity means that an opportunity for more revenue has been lost, whereas increasing sales beyond this quantity means that MR becomes negative and TR falls. TR QRM Quantity C/R MC AC p. RM c. RM D = AR QRM MR Quantity

Sales Maximisation Business Objectives Mr O’Grady

Sales Maximisation Definition: Sales maximisation is a C/R theoretical objective of a firm which involves selling as many units of a good or service as possible, without making a loss. Firms may pursue sales max instead of profit max in order to increase their market share/deter rivals from entering This means sacrificing some short-term profit with a view to achieving a longer -term gain by being the largest firm in the market in future. Condition: occurs where AC = AR, with the firm making normal profits Analysis: Any more sales will see the firm make a loss as it’s average revenue is below its average cost MC AC p/c. SM D = AR MR QSM Quantity

Profit Satisficing Business Objectives Mr O’Grady

Profit Satisficing Definition: Profit satisficing is a decision. C/R making strategy that aims for a satisfactory or adequate profits, rather than the profit max. p. PM Rather than put maximum exertion towards attaining the most ideal outcome, satisficing focuses on pragmatic effort when confronted with tasks. Condition: occurs at a quantity with supernormal profit, but not at profit max, where MR = MC, Analysis: The strategy can include adopting an approach that requires meeting a set of minimum standards that meets basic acceptable outcomes over a broader range of goals. Example: Football clubs, the NHS MC AC c. PM D = AR QPS MR Quantity

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