Profit Maximization
scheduleIntroduction To Profit AndProfit MaximizationSlides
from3 - 8Total Slides 6ArslanWani - 42Objective , P.Max Model ,
Implication , Factors & TheoriesSlides from9 - 15
Total Slides 7Javaid Iqbal - 22Total Revenue , Marginal Revenue
, Marginal CostSlides from16 - 24Total Slides 9Junaid Jamal -
38Example Of Profit Max. & Its ApplicationSlides from25 -
28Total Slides 4Aabid Hussain - 39Graphs , Video & How To
Maximize ProfitSlides from29 - 36Total Slides 8Muneeb Lone -
08Advantages And Disadvantages Of Profit MaximizationSlides from37
- 40Total Slides 4Qaiser Beigh - 48Profit MaximizationPresented
by:Abid Hussain 39Arslan Wani 42Javaid Iqbal 22Junaid Jamal
38Muneeb Lone 08Qaiser Beigh 48
Presented to:Dr. FAROOQ AHMAD KHAN
Profit:Profit-makingis one of the most traditional, basic
andmajor objectives of a firm. Profit-making is the driving-force
behind all business activities of a company. It is the primary
measure of success or failure of a firm in the market.
Profit earning capacityindicates the position, performance and
status of a firm in the market. It is an acid test of economic
ability and performance of an individual firm. There is no place
for a firm unless it earns a reasonable amount of profit in the
business.Earlier profit maximization was the sole objective of a
firm. This assumption has a long history in economic literature and
the conventional price theory was based on this very assumption
about profit making. In spite of several changes and development of
several alternative objectives, profit maximization has remained as
one of the single most important objectives of the firm even
today.
Specific efforts have been made to maximize output and minimize
production and other operating costs. Costs reduction, cost cutting
and cost minimization has become the slogan of a modern firm.
Profit Maximization:An Introduction.A process
thatcompaniesundergo todeterminethe bestoutputandprice levelsin
order to maximize itsreturn.The company will usually adjust
influentialfactorssuch as productioncosts,sale prices, and
outputlevelsas a way of reaching itsprofitgoal.There are
twomainprofit maximization methods used, and they
areMarginalCost-MarginalRevenueMethod andTotalCost-Total Revenue
Method.We usually assume firm managers to maximise profits that is
the difference between total revenue and total costsWe draw a
distinction between economic profits and accounting
profits.Economic profits = sales revenue economic cost.Account
profit = sales revenue accounting cost.Economic cost include all
relevant costs including opportunity costs.PM is consistent with
maximising market value (i.e., stock price) of the firm.
Profit maximization is the rational behaviour
ofequilibriumassumption. Any firm which aiming at profit
maximization model; will go increasing its output till it reaches
maximum profit output. Profit is known nothing but differences
between total revenue and total cost. The more the differences
between total revenue and total cost will create maximum profit.
So, the equilibrium for a firm will be when there is maximum
difference between the total cost and total revenue.Profit
maximization is a good thing for a company, but can be a bad thing
forconsumersif the companystartsto use cheaperproductsor decides to
raiseprices.
Profit maximization is the most important objective of a
business entity. Every business, in addition to striving for the
attainment of other objectives, does its best with special
importance to make profits. Profit is to be regarded as a yardstick
against which are assessed or measured the quality and value and
the success of a business.As has been mentioned above, profit
maximization is the most necessary aspect of a business entity as
it helps to run a business smoothly and successfully and survive
continuously while making profits and staying solvent at the same
time as providing various benefits. Objectives:The objective of a
for-profit firm is to maximize profit. Profit is total revenue less
the costs of the resources (land, labor, capital) used. Total
revenue is the price of goods and services multiplied by the
quantity sold, PQ.Profit is the difference between total revenue
and total cost.
Profit = PQ Cost of land, labor and capital10Profit Maximization
ModelProfitMaximizationmodelhelps to predict the price-output
behaviour of a firm under changing market conditions like tax
rates, wages and salaries, bonus, the degree of availability of
resources, technology, fashions, tastes and preferences of
consumers etc. It is a very simple and unambiguous model. It is the
single most ideal model that can explain the normal behaviour of a
firm. It is often argued that no other alternative hypothesis can
explain and predict the behaviour of business firms better
thanprofit-maximization hypothesis. This model gives a proper
insight in to the working behaviour of a firm. There are well
developed mathematical models to explain this hypothesis in a
systematic and scientific manner.
Implication of P.Max ModelProfit-maximization implies earning
highest possible amount of profits during a given period of time.A
firm has to generate largest amount of profits by building optimum
productive capacity both in the short run and long run depending
upon various internal and external factors and forces.In the short
run a firm is able to make only slight or minor adjustments in the
production process as well as in business conditions. The plant
capacity in the short run is fixed and as such, it can increase its
production and sales by intensive utilization of existing plants
and machineries, having over time work for the existing staff etc.
Thus, in the short run, a firm has its own technical and managerial
constraints.In the long run, as there is plenty of time at the
disposal of a firm, it can expand and add to the existing
capacities, build up new plants, employ additional workers etc to
meet the rising demand in the market. Thus, in the long run, a firm
will have adequate time and ample opportunity to make all kinds of
adjustments and readjustments in production process and in its
marketing strategies.
Factors Affecting P.MaxPricing and business strategies of rival
firms and its impact on the working of the given firm.Aggressive
sales promotion policies adopted by rival firms in the
market.Without inducing the workers to demand higher wages and
salaries leading to rise in operation costs.Without inducing the
workers to demand higher wages and salaries government controls and
takeovers.Maintaining the quality of the product and services to
the customers.
Factors cont.Taking various kinds of risks and uncertainties in
the changing business environment.Adopting a stable business
policy.Avoiding any sort of clash between short run and long run
profits in the business policy and maintaining proper balance
between them.Maintaining its reputation, name, fame and image in
the market.Profit maximization is necessary in both perfect and
imperfect markets. In a perfect market, a firm is a price-taker and
under imperfect market it becomes a price-searcher.
Theories of P.MaxEconomist Theory of Firm: According to the
Economist Theory of Firm, a firm is a transformation unit, which
converts input into output and while doing so, tries to create
surplus value. This surplus value is nothing but the difference
between the value of the product and the value of the factors of
production. The firm aiming for profit maximization reaches its
equilibrium only when it produces profit maximizing output. The
firm maximizes profit by equating marginal revenue with marginal
cost.Theories cont.Williamsons Managerial Discretionary Theory:
According to the theory, in a firm, shareholders and managers are
two separate groups. The firm tries to get maximum returns on
investment and get maximum profit, whereas managers try to maximize
profit in their satisfying function. At last, Williamsons
managerial discretion theory shows the utility function of a
manager. In this theory, the firm will try to get maximum returns
or maximum profit where as manager try to maximum utility
satisfying function. They are in equilibrium when the utility has
maximum amount.
Total RevenueTotal Revenue = Price X QuantityProfit-Maximizing
Level of OutputWhat happens to profit in response to a change in
output is determined by marginal revenue (MR) and marginal cost
(MC).A firm maximizes profit when MC = MR.MARGINAL REVENUE (MR)The
change in total revenue associated with a change in quantity.The
increase in revenue that results from the sale of one additional
unit of output.Marginal revenue is calculated by dividing the
change in total revenue by the change in output quantity. While
marginal revenue can remain constant over a certain level of
output, it follows the law of diminishing returns and will
eventually slow down, as the output level increases.Perfectly
competitive firms continue producing output until marginal revenue
equals marginal cost.MARGINAL COST (MC)Change in the total cost as
a result in the change of unit cost is known as Marginal cost. (Dr.
Farooq Ahmad Khan)Marginal costs arevariable costsconsisting
oflabourandmaterial costs,plus administrationoverheads
anestimatedportion of fixed costs (such asandselling expenses).
Incompanieswhereaverage costsare fairly constant, marginalcostis
usually equal to average cost. However, inindustriesthat require
heavycapital investment(automobileplants, airlines, mines) and
havehighaverage costs, it is comparatively verylow.Theconceptof
marginal cost is critically important in resourceallocationbecause,
foroptimumresults, managementmust concentrate itsresourceswhere
theexcessofmarginal revenueover the marginal cost is maximum.
Alsocalledchoicecost,differential cost, or incremental cost.
Marginal Revenue and Marginal CostThe Profit maximizing quantity
of output can be determined by comparing marginal revenue and
marginal cost. Marginal cost is the additional cost of producing
one more unit of output. Marginal revenue is the additional revenue
from selling one more unit of output.Profit is maximized at the
output level where marginal revenue and marginal cost are equal.
The supply rule is: Produce and offer for sale the quantity at
which MR=MC.21MR and MCMarginal Revenue = Change in Total
Revenue/Change in Total OutputMR = TR/Q
Marginal Cost = Change in Total Cost/Change in Total OutputMC =
TC/QComparing marginal revenue and marginal cost determines whether
the firm needs to supply more or less in order to maximize
profit.22MR > MCIf marginal revenue exceeds marginal cost, the
production of an additional unit of output adds more to revenue
than to costs.In this case, a firm is expected to increase its
level of production to increase its profits.
MR < MCIf marginal cost exceeds marginal revenue, the
production of the last unit of output costs more than the
additional revenue generated by the sale of this unit.In this case,
firms can increase their profits by producing less.A
profit-maximizing firm will produce more output when MR > MC and
less output when MR < MC.MR = MCIf MR = MC, however, the firm
has no incentive to produce either more or less output. The firm's
profits are maximized at the level of output at which MR = MC.
An example of profit max.Suppose a business that produces and
sells college boards. In a typical day you produce three boards.
You are able sell these boards for Rs500 a piece. You employ five
workers, each of whom earns Rs15 per hour (Rs120 per day), and you
work alongside them and pay yourself at the same rate. Material
inputs cost Rs150 per board. Of course, you have additional
"overhead" expenses, including rent, a secretary/bookkeeper,
electricity, etc. and it's afixed cost which comes to Rs130 per
day. Thus, your company earns a profit of P = (Rs500 x 3) - (Rs720
+ 450 + 130) = Rs1500 - Rs1300 = Rs200 per day Working five days a
week for 50 weeks a year, that comes to an annual profit of
Rs50,000.
Suppose you decide to increase production to four boards per
day. This requires you to hire two more workers (at another Rs240)
and purchase another Rs150 worth of materials. Overhead expense
doesn't change. Your total cost rises to Rs1690. You find that you
are able to sell the fourth board for Rs500. Total revenue rises to
Rs2000 per day, while total costs rise to Rs1690. Profit increases
to Rs310 per dayThis nice result may lead you to increase
production to five boards a day. If you are able to sell all five
boards for Rs500 each, and if yourvariable costsof producing the
boards - what you pay in labour and materials - doesn't increase,
producing a fifth board makes sense. TR rises to Rs2500, TC rises
to Rs2080, and profit increases to Rs420. So you sell five
boards.Suppose, however, that you find that the labour market is so
tight that you cannot hire another two workers at Rs15 per hour. In
fact, to hire your ninth and tenth workers, you must pay Rs20 per
hour. That increases the labour cost of the fifth board by Rs80
(Rs40 per worker times two workers). TC rises to Rs2160, which
still allows profit to increase to Rs340. But we have a problem
brewing. Can you really get away with paying your veteran workers
Rs15 an hour, while at the same time hiring new workers at Rs20 per
hour? Not likely. So when you hire the ninth and tenth workers, you
are forced to raise the wages of your first eight workers. Let's
recalculate profit for Q = 5. TR = Rs500 x 5 = Rs2500. TC = (Rs160
x 10) + (Rs150 x 5) + Rs130 = Rs2480. That leaves a profit of Rs20.
Doesn't look like such a good idea now, Thus, if you realize that
your costs will rise sharply if you produce a fifth board each day,
you will decline to produce the board.APPLICATIONOur little example
illustrates the situation every business owner or manager faces.
Businesspeople know what their current position is (revenue and
costs) and they can estimate TR and TC for a higher (or lower)
level of production. By actually changing output levels, they learn
by experience what their demand and cost curves look like. In the
process, they discover what happens to profit as they change output
levels. Through this discovery process, businesspeople seek to find
the output level that maximizes profit.
As omniscient onlookers, we can describe this process a bit more
analytically. A firm should increase its output so long as the
marginal revenueis greater than themarginal costof those units. As
long as MR > MC, profit grows. However, when MR < MC, profit
shrinks. So firms expand output only to the point at which MR = MC.
This point maximizes profit.
The profit-maximization rule applies both to firms that are able
to sell their product at a constant price and to firms that find
they must reduce the price of their product to increase sales. In
the real world, firms have to engage in trial-and-error discovery
processes, searching for the profit-maximization point. But the
process can be succinctly described by the marginal
revenue-marginal cost rule
Profit Maximization
30Profit: downward-sloping demand of price-setting
firmprofitAveragecostQuantityProfit-maximizing priceQMAX0Costs
andRevenueDemandMarginal costMarginal revenueAverage costBCEDShut
down because P < AC at all Q: downward-sloping demand of
price-setting firmQuantity0Costs andRevenueDemandAverage total
costProfit Maximization: horizontal demand for a price taking
firmQuantity0CostsandRevenueMCACMC1Q1MC2Q2The firm maximizesprofit
by producing the quantity at whichmarginal cost equalsmarginal
revenue.QMAX P = MR1 = MR2 P = AR = MRShut down because P < AC
at all Q: horizontal demand for a price taking
firmQuantity0CostsandRevenueMCAC P = AR = MRACminPROFIT
MAXIMIZATION
How to Maximize ProfitIf marginal revenue does not equal
marginal cost, a firm can increase profit by changing output.The
supplier will continue to produce as long as marginal cost is less
than marginal revenue.How to Maximize ProfitThe supplier will cut
back on production if marginal cost is greater than marginal
revenue.Thus, the profit-maximizing condition of a competitive firm
is MC = MRAdvantagesProfit maximization is the basic objective of
any business to survive and to remain in the money.A business which
fulfils the objective from the perspective of profit maximization,
can maintain sufficient funds at all times while maintaining
working capital effectively and efficiently.Objective of profit
maximization is leading the business organization in the direction
of profitability and prosperity while safeguarding against the
possibility of insolvency.
Cont.Profit maximization carries the big advantage of creating
cash flow. When maximizing profit is the primary consideration,
investments, reinvestments and expansions are typically tabled. In
the mean time, the profits keep building, producing a healthy
bottom line and increasing the firms amount of available cash.Some
degree of profit maximization is always present. The goal of a
company is to create profits. It has to profit from its business to
stay in business. Moreover, investors and financiers in the company
may require a certain level of profits to secure funds for
expansion.. As such, maximizing that profit is always a
consideration to some extent.DisadvantagesProfit maximization is
the focus of a company on their profits ahead of everything else.
This means that they will use all of the resources they have to
increase profits. This process sounds like a win-win situation, but
it does come with some disadvantages, namely risk. Using this type
of strategy causes some risks to the company. It is possible to
lose all market value if the market takes a turn while all
resources are set to creating a profit.Pursuing a profit
maximization strategy comes with the obvious risk that the company
may be so entrenched in the singular strategy meant to maximize its
profits that it loses everything if the market takes a sudden
turn.Cont.If a company focuses only on maximizing its profit, it
may miss opportunities for investment and expansion.Profit
maximization is an inappropriate goal because it leads to inflation
and irregular distribution of wealth. It also makes one run the
risk of losing employees and mostly it restricts quality.If a
company pursues a profit maximization strategy, it creates an
environment where price is a premium and cutting costs is a primary
goal. This, in turn, creates a perception of the company that could
lead to a loss of goodwill with customers and suppliers.It also
creates an expectation of shareholders to see immediate gains,
rather than realizing profits over time.That's all Friends Thanks
for Your Kind Attention..