profit maximization


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Profit maximizationclick for a larger image
Fig. 161 Profit maximization.

profit maximization

the objective of the firm in the traditional THEORY OF THE FIRM and the THEORY OF MARKETS. Firms seek to establish the price-output combination that yields the maximum amount of profit. The achievement of profit maximization can be depicted in two ways:
  1. firstly, where TOTAL REVENUE (TR) exceeds TOTAL COST (TC) by the greatest amount. In Fig. 161 this occurs at the output level where the slope of the two curves is identical and tangents to each curve are consequently parallel, as at Qe. At any output level below Qe, the relevant tangents would be diverging - the TR and TC curves would still be moving farther apart and profits would still be rising. At any output level beyond Qe, on the other hand, the relevant tangents would be converging and the profit surplus of TR over TC would be falling. Thus, Qe is the optimum point, for here the distance between the total revenue and total cost curves is maximized (equal to AB). The difference between the two curves shows up in the total profit curve, which becomes positive at output OQ1, reaches a maximum at output OQe (where profit CD = AB) and becomes negative beyond output OQ2 ;
  2. secondly, profit maximization can be shown to occur where MARGINAL REVENUE (MR) equals MARGINAL COST (MC) - at output OQe in the figure. At all output rates above OQe, additional units add more to cost than revenue, so total profits are reduced. At all output rates less than OQe, additional units add more to revenue than cost, thereby expanding total profits. Only where MR = MC are profits maximized. See FIRM OBJECTIVES.
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