Profit is the goal for any entrepreneur, taking into account which the effectiveness of business activities is measured. Manufacturers intend to maximize the financial result, which depends on many factors: costs, output, quantity of resources and their combination. The primary task of the economist at the enterprise is to find the volume at which the financial results will be satisfactory. To do this, you must follow the rules of maximizing profits, which are based on the ratio of marginal revenue and costs.
Revenue and profit
The financial resources that remain at the disposal of the enterprise after deduction of economic costs from revenue are equated with profit. The price of production and quantity directly affect the volume of total revenue or gross income (TR). That is, the profit (P) of the enterprise is the difference between TR and TS, where TS is the gross (total) costs.
Comparing the gross indicators of income and costs, we get different values of profit:
- provided that TP> TS, profit is higher than 0;
- if, on the contrary, TP <TS, the profit is negative;
- if TP = TS, then P = 0 (this is the state when the company does not receive profit, but also does not incur losses).
Carrying out the production of goods (goods, services), the economic entity seeks to increase profits. Profit maximization is the determination of the optimal volume of production of these goods.
Determination of the optimal volume
There are 2 approaches to identifying the number of products / services at which the activity of an economic entity will be effective. Profit maximization conditions:
- To produce products in such a volume that the difference between the TP and TS indicators reaches its maximum value.
- When comparing the marginal values of income (MR) and costs (MS), their equality should be fulfilled.
To understand the second condition, it is necessary to recall or study the definition of marginal costs and income.
Marginal revenue and costs
Marginal revenue - an additional (additional) result of the enterprise from the sale of each subsequent unit of goods. The value of MR is determined by the ratio of gross revenue (ΔТР) to the additionally issued unit of good - goods / services (ΔВ).
Marginal costs determine how much more resources will be needed to produce an additional unit of output.
That is, each subsequent unit of goods, the marginal cost of which is less than the marginal income, must be produced, because the company will receive more income from each such sold unit than it will spend resources. As soon as MR = MS, the increase in volume should be stopped, since with such equality the highest profit of the company is achieved. The conditions for maximizing profit have been achieved.
Loss minimization
The previously considered conditions for maximizing profit, which are fulfilled when the optimal volume of production is achieved, give one result. That is, if for the same company to determine the optimal output, then when using the first or second condition, the same amount of volume will be achieved.
If economic losses are detected, the manufacturer is also forced to establish the volume of production at which the losses will be the smallest. This is possible provided that the difference between gross costs and revenue is minimal.
Minimization of company losses is achieved when the price of the last unit of output is equal to marginal cost. But the price should not exceed average gross expenses (ATS) and should be higher than average variable costs (ABC). With perfect competition, when the manufacturer is not able to influence the value of the goods, MP (marginal revenue) is equivalent to the price (P) of a unit of production. Then MR = MS = P if ABC
Market price and average costs
So, the rule of maximizing profits in conditions of perfect competition is characterized by the equality MP = MS = P. A price appears in the equation, which must be compared with the costs for generating economic profit.
Average cost (AC) is defined as the quotient of gross expenditure and output. They are of three types:
- ATS - gross;
- ABC - variables;
- APS - constants.
Value for money:
- P> ATS - the case in which the economic profit of the company is achieved. The conditions for maximizing profit are such that revenues are higher than costs.
- P = ATS. The company covers its expenses without receiving financial benefits.
- P <ATS is characteristic of losses.
- ABC
Profit in imperfect competition
In a market situation where manufacturers can control prices, demand decreases, and then the rules for maximizing profits change. The manufacturer poses the question: reduce the price or reduce the volume of output.
But with imperfect competition, the greater the sales volume, the lower the price of the goods, and each additional unit of production is sold at a low price. That is, to sell an additional unit, the manufacturer reduces the price. On the one hand, the effect of increasing sales is created, on the other hand, the company suffers losses because buyers pay less.
Relative loss reduces marginal revenue (MR), which does not match the selling price. Ways to maximize profits with perfect and, conversely, imperfect competition have a common condition: MR = MS. But in each case there are peculiarities that can be considered when studying the types of market imperfect competition.
Monopoly Profit
The market in which one manufacturer sells goods that do not have similar samples with a similar set of characteristics is called a monopoly. Lack of competitors is the main condition for monopoly. In practice, especially at the global and national levels, such a market model is rare, but occurs locally.
The uniqueness of the product is forced to force the buyer to purchase it at the price set by the manufacturer, or to abandon it altogether. But if the price is too high, then purchasing power will be reduced. Therefore, the goal of a monopolist to maximize profits is not only to determine the volume, but also to establish the price of the goods at which all products produced by the enterprise will be sold.
To obtain high profit margins, the condition is mandatory: P> MP = MS. First, according to the well-known equality MP = MS, the monopolist firm establishes the optimal volume of output of the good, and then, comparing the marginal income with the price, sets its value by the equation P> MR.
Profit at oligopoly
A small number of large firms competing among themselves is characteristic of an oligopoly. The close relationship of firms affects their pricing behavior. The competitors' strategy is a fundamental factor in determining the price of goods and the volume of output.
With this type of market structure, the equality MR = MS does not apply, at which the optimal volume is found and high profit is achieved. Profit maximization in oligopoly:
- product differentiation;
- quality improvement;
- unique design;
- increasing the level of service.
