Profit maximization is a process by which a firm determines the price and output of a product that yield the greatest profit. A producer’s equilibrium is a situation in which he maximizes his profits and minimizes his loss.
There are two methods for determination of Producer’s Equilibrium:
- Total Revenue and Total Cost Approach (TR-TC Approach)
- Marginal Revenue and Marginal Cost Approach (MR-MC Approach)
# CONCEPT OF COST :
In order to produce goods, a firm uses various inputs such as raw material, land, labour, capital etc. The expenditure incurred on these inputs is known as cost of production. Any cost incurred in short period by a firm is divided into two components: fixed cost and variable cost.
- Fixed costs (FC) are incurred by the business on the purchase and hiring of fixed factors of production. These include equipment maintenance, rent, wages and general upkeep.
- Variable costs (VC) change with the level of output, increasing as more product is generated and remains zero when the output is zero. Fixed cost and variable cost combined together to form the total cost.
Other two types of cost that are an important determinant in profit maximization process are the : Average cost is a cost per unit of output produced. In short period, It is a sum total of AFC + AVC. and Marginal cost is a change in total cost by producing one more or one less unit of output.
# CONCEPT OF REVENUE :
Revenue of a firm is its money receipts from sale of a product.Other important concept of revenue includes : Marginal revenue is a change in the total revenue on account of one more or one less unit of output. whereas Average revenue is a per unit revenue received from the sale of a commodity.
# PROFIT MAXIMIZATION :
It is assumed that a producer is guided by consideration of profit maximization, even though his production decisions may be determined by some other factors also i.e sales maximization.
(1) Total Revenue and Total Cost Approach (TR-TC Approach)
Implying that a rational producer always wishes to enhance the surplus of TR over and above TC. Profit of a producer is calculated by difference between total cost (TC) and its total revenue (TR) obtained from the sale of given level of production.
PROFIT = TR – TC
With a view to maximize profits, a producer will produce up to that quantity where the difference between TR and TC is maximum.
In Fig. 8.2, producer’s equilibrium will be determined at OQ level of output at which the vertical distance between TR and TC curves is the greatest. At this level of output, tangent to TR curve (at point H) is parallel to the tangent to TC curve (at point G) and difference between both the curves (represented by distance GH) is maximum. IN other words, the firm will be grtting HG the maximum profit. on contrary at OQ1 and OQ2 amount of output, the TC=TR. It means the firm is getting no profit.
(2) Marginal Revenue and Marginal Cost Approach (MR-MC Approach)
With a view to maximize profits, a producer will produce up to that quantity where the following two conditions are satisfied :
- Marginal revenue (MR)= Marginal cost (MC)
- MC should be rising
Producer’s Equilibrium is determined at OM level of output corresponding to point E as at this point: (i) MC = MR; and (ii) also at point E, MC is rising. Hence firm will produce maximum profit by producing OM output.
In Fig. 8.4, output is shown on the X-axis and revenue and costs on the Y-axis. If a firm produces less than OM level of output, its MR will be more than MC. It points to the possibility of greater profits. On the other hand if a firm produces more than OM , then its MC > MR. It points to situation of emerging losses. Thus firm will produce maximum profits by producing OM output alone, Where both the conditions are fulfilled.
# PROFIT MAXIMIZATION UNDER PERFECT COMPETITION :
Under perfect competition, price remains constant and a firms can sell any quantity of output at the price fixed by the market. constant Price implies constant AR. Also, the revenue from every additional unit (MR) is equal to AR. It means, AR curve is same as MR curve. Thus for all level’s of firm output, AR and MR are represented by same horizontal line.
Producer’s Equilibrium is determined at OQ level of output corresponding to point K as at this point: (i) MC = MR; and (ii) MC is greater than MR after MC = MR output level. In Fig. 8.3, output is shown on the X-axis and revenue and costs on the Y-axis. Both AR and MR curves are straight line parallel to the X-axis. MC curve is U-shaped. Producer’s equilibrium will be determined at OQ level of output