Profit Maximization:
Profit maximization is the main goal of an organization, where they want to make sure that they get as much profit as possible by deducting costs from their revenue. For a business or organization, profit maximization means the point at which the difference between total revenue and total cost is greatest.
Basic concept of profit maximization:
Total Revenue (TR): Product of quantity sold and selling price.
Total Cost (TC): The total cost associated with the production process.
Total Profit (TP): What remains after subtracting total costs from total revenue.
Source : TP=TR−TC
Objective of profit maximization:
The objective of profit maximization is to find the production or sales level at which the business can earn its maximum profit. For this it is important to maintain a balanced relationship between production cost and selling price.
Two methods of profit maximization:
1. Total Revenue and Total Cost Method:
In this method profit is maximum when the difference between total revenue and total cost is maximum. In this case, the firm aims to reach the sales volume where the difference between the two is greater.
Example 01:
Let’s say a company produces and sells 100 units of product. The selling price of each unit is $100 and the cost of production is $70. However, fixed costs $10,000.
Total revenue (TR) = Quantity of goods sold × Selling price per unit
TR= 100×100 = $10,000
Total Cost (TC) = (Production Cost × Product Quantity) + Fixed Cost
TC= (70×100)+10,000 = 7,000 + 10,000 = $17,000
Total Profit (TP) = Total Revenue – Total Cost
TP = 10,000 – 17,000 = ($7,000) loss
Here the company is facing loss, so to maximize profit they need to increase sales volume or reduce costs.
2. Marginal Revenue and Marginal Cost Method:
In this method profit is maximized when Marginal Revenue (MR) and Marginal Cost (MC) are equal. Here, the additional revenue incurred in producing each new unit is compared with the additional cost incurred.
Source:
Profit is maximized when: MR=MC
Example 02:
A business organization is getting marginal cost of $30 and marginal revenue of $50 for producing first 50 units. Then the marginal cost of producing the 51st unit increases to $50 and the marginal revenue is $50.
Marginal revenue > marginal cost up to first 50 units, i.e. company is making profit.
But at production of 51st unit marginal cost and marginal revenue become equal (MR = MC), i.e. profit is maximized here.
In this case, the company may stop production after the 51st unit is produced, as increasing production thereafter may reduce profits.
Profit Maximization Strategy:
1. Pricing Strategy:
Firms consider market demand, competition, and production costs when setting product prices to determine a price that will maximize profits.
2. Cost Control:
Profits can be increased by controlling production costs. Organizations try to reduce production costs by using cost-cutting measures such as increasing worker efficiency, using modern technology.
3. Market Expansion:
One can try to maximize profits by entering new markets or introducing new products. In this case, companies can expand their products and sell more.
More Resources
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