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Profit maximization using the total revenue and total cost curves of a perfect competitor. To obtain the profit maximizing output quantity, we start by recognizing that profit is equal to total revenue minus total cost (). Given a table of costs and revenues at each quantity, we can either compute equations or plot the data directly on a graph.
In perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost (P = MC). This implies that a factor's price equals the factor's marginal revenue product . It allows for derivation of the supply curve on which the neoclassical approach is based.
Intuitively, this is because starting from such a point, a reduction in quantity and the associated increase in price along the demand curve would yield both an increase in revenues (because demand is inelastic at the starting point) and a decrease in costs (because output has decreased); thus the original point was not profit-maximizing.
In interdependent markets, It means firm's profit also depends on how other firms react, game theory must be used to derive a profit maximizing solution. Another significant factor for profit maximization is market fractionation. A company may sell goods in several regions or in several countries.
The company maximises its profits and produces a quantity where the company's marginal revenue (MR) is equal to its marginal cost (MC). The company is able to collect a price based on the average revenue (AR) curve. The difference between the company's average revenue and average cost, multiplied by the quantity sold (Qs), gives the total profit.
Profit maximization requires that a firm produces where marginal revenue equals marginal costs. Firm managers are unlikely to have complete information concerning their marginal revenue function or their marginal costs. However, the profit maximization conditions can be expressed in a “more easily applicable form”: MR = MC, MR = P(1 + 1/e),
The mathematical profit maximization conditions ("first order conditions") ensure the price elasticity of demand must be less than negative one, [2] [7] since no rational firm that attempts to maximize its profit would incur additional cost (a positive marginal cost) in order to reduce revenue (when MR < 0). [1]
C. Robert Taylor points out that the accuracy of Hotelling's lemma is dependent on the firm maximizing profits, meaning that it is producing profit maximizing output and cost minimizing input . If a firm is not producing at these optima, then Hotelling's lemma would not hold. [2]