schedule

Introduction To Profit
And
Profit Maximization

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3-8
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Total Revenue ,
Marginal
Revenue , Marginal
Cost

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16 - 24

Example
Of
Profit
Max. & Its Application

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Objective , P.Max
Model ,
Implication , Factors &
9 - 15
Theories

Graphs , Video & How

To Maximize Profit

Arslan
Wani - 42

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Javaid
Iqbal - 22

7
Junaid
Jamal - 38

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Aabid
Hussain 39

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Muneeb
Lone - 08

29 - 36

Profit Maximization
Pr e s e n t e d b y :
Abid Hussain 39
Arslan Wani
42
Javaid Iqbal 22
Junaid Jamal 38
Muneeb Lone 08
Qaiser Beigh 48
Pr e s e n t e d t o :
Dr. FAROOQ AHMAD KHAN

Profit:

Profit-makingis one of the most traditional,

basic andmajor objectives of a firm. Profitmaking 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 areMarginalCostMarginalRevenueMethod
andTotalCostTotal Revenue Method.

We usually assume firm managers to

maximise profits that is the difference
between total revenue and total costs
We
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

Profit Maximization
Model

ProfitMaximizationmodelhelps to predict the priceoutput 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 thanprofitmaximization 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
Model

Profit-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.

1)

2)
3)

4)

5)

Factors Affecting
P.Max

Pricing 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.
6)

Taking various kinds of risks and uncertainties in

the changing business environment.

7)

Adopting a stable business policy.

8)

Avoiding any sort of clash between short run and

long run profits in the business policy and
maintaining proper balance between them.

9)

Maintaining its reputation, name, fame and

image in the market.

10)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.Max

Economist 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 Revenue
Total Revenue =

Price X
Quantity

Profit-Maximizing Level
of Output

What 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

Marginal Revenue
and Marginal Cost

The 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.

MR and MC

Marginal Revenue = Change in Total

Revenue/Change in Total Output

MR = TR/Q

Marginal Cost = Change in Total

Cost/Change in Total Output

MC = TC/Q

Comparing marginal revenue and marginal

cost determines whether the firm needs to
supply more or less in order to maximize
profit.

MR > MC

If 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 < MC

If 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 = MC

If 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 day
This 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.

APPLICATION

Our 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 revenuemarginal cost rule

Profit Maximization

Profit: downward-sloping
demand of price-setting firm
Costs and
Revenue
Marginal cost
ProfitE
maximizing
price

profit

Average
cost D

Average cost

C
Demand

Marginal revenue
0

QMAX

Quantity

Shut down because P < AC at all Q:

downward-sloping demand of price-setting
firm
Costs and
Revenue
Average total cost

Demand
0

Quantity

Profit Maximization: horizontal

demand for a price taking firm
Costs
and
Revenue

The firm maximizes

profit by producing
the quantity at which
marginal cost equals
marginal revenue.

MC

MC2
AC
P = MR1= MR2

P = AR = MR

MC1

Q1

QMAX

Q2

Quantity

Shut down because P < AC at all Q:

horizontal demand for a price taking firm
Costs
and
Revenue
MC

AC

ACmi
n

P = AR = MR

Quantity

PROFIT MAXIMIZATION

How to Maximize Profit

If 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 Profit

The 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 = MR

Advantages
Profit
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

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

Disadvantages

Profit 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

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

That's all Friends

Thanks for
Your Kind
Attention..