Maximizing Profit
● This unit is basically all about asking what exact quantity of the output will maximize a
company’s profit
● The profit-maximizing rule (also known as the optimal output rule) states that a
company should increase production of an output until the marginal cost of producing a
unit of the output equals the marginal revenue they get from selling that unit of output
○ You should continue producing outputs until the marginal revenue of doing so
equals the marginal cost
○ Total revenue is equal to the price of an individual unit of output multiplied by the
quantity of outputs sold
● The total profit is equal to the total revenue minus the total costs of producing that
quantity of outputs
○ When the total profit is maximized, that is, when you can’t produce more
quantities of output without the total profit going down, that gives you the quantity
of outputs produced that would maximize your profit.
○ This quantity is also the same as when you calculate it by using MR = MC
(marginal revenue of producing one more unit is equal to the marginal cost of
producing one more unit)
Using Marginal Analysis to Choose the Profit-Maximizing Quantity of
Output
● The principle of marginal analysis states that you should stop doing something when
the marginal benefit of doing so equals the marginal cost
○ In respect to companies that want to maximize profits, for them the marginal
benefit is the marginal revenue, how much money they get from selling one
more unit of output
○ Marginal revenue (MR) of a unit of an output is equal to the
○
○ The marginal revenue might not always equal marginal cost at the most optimal
output production quantity. If that happens, remember that the optimal output
quantity in that instance equals the greatest output production point where
the marginal revenue is greater than the marginal cost, stop producing if
the next unit would cause the marginal cost to rise above the marginal
revenue
● The marginal revenue curve is the relationship between the marginal revenue and the
quantity of outputs sold (it shows how the marginal revenue for one extra unit of output
varies as the total output varies)
○ In a perfectly competitive market the marginal revenue curve is flat
○ The marginal cost curve of a firm should intersect the marginal revenue curve at
the profit maximizing quantity for perfectly competitive markets
● NOTE: this is all just assuming markets are perfectly
competitive, and that the marginal revenue you get from
selling one extra unit of output doesn’t decrease or increase
the more you sell it at
● Remember, before deciding how much of a good to produce in order for MR = MC,
you need to calculate if you should produce at all, you need to ask “either I do
this, or I can do that, which earns me more money”
○ You need to calculate your Economic Profit, to make sure that you can’t be
spending your time doing other things that would earn you more money than
selling a quantity of outputs.
When is Production Profitable
● To decide if you’re better off doing something else with your time remember that you
need to calculate your economic profit, which is your accounting profit (only counting
explicit costs) minus your implicit costs (the lost opportunities and the value of the things
that you could’ve been doing)
○ If your economic profit is negative then in the long-run you should move out of
the business. Why would you stay in it? No matter if you’re earning money and
your accounting profit is positive, you’d still be better off doing something else
with your resources
○ A decision to stay in the market or not in the long-term should always only
depend on your economic profit
● What determines whether a company operates at a loss is whether the profit-maximizing
quantity of output results in at least a normal economic profit. A firm can have a
positive accounting profit but still face a negative economic profit and would be
better off leaving the market if implicit costs are high.
Operating at the profit-maximizing output quantity (MR=MC) ensures that the firm has a
positive accounting profit, but what truly matters is whether, after accounting for implicit
costs, the firm achieves at least a normal profit. If it do es, the firm is operating
sustainably; if not, it is effectively operating at a loss.