chapter 14
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Chapter 14. Profit maximisation and output determination. To begin with … 14.1Objectives of private enterprises 14.2Determination of profit- maximising output 14.3Marginal cost schedule = Supply schedule. To begin with …. We have learned that: - PowerPoint PPT PresentationTRANSCRIPT
Chapter 14
To begin with …14.1Objectives of private enterprises 14.2Determination of profit-
maximising output14.3Marginal cost schedule = Supply schedule
Profit maximisation and output determination
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Chapter 14
To begin with …
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We have learned that: Public enterprises aim to serve society by providing
public services at low prices. Private enterprises aim to maximise profits.
Do private enterprises have other objectives?
How do they decide on the amount of their output to maximise their profit?
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Task 14.1Benjamin runs a bakery. He is facing some problems in his business and is thinking of the ways to deal with them.
Want the poor to enjoy my bread and cakes
Earn more profit to buy a diamond ring
Livelihood of the cashier
Enlarge customer base to expand my business
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Task 14.1
Want the poor to enjoy my bread and cakes
Earn more profit to buy a diamond ring
Livelihood of the cashier
Enlarge customer base to expand my business
If you were Benjamin, what would you do?Answers will be provided in the final version.
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14.1 Objectives of private enterprises
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14.1 Objectives of private enterprises
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Objectives of private enterprises
Profit maximisation
Market share maximisation
Corporate social
responsibility
Provision of non-profitmaking
goods and services
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A. Profit maximisationProfit is the net receipts of a firm or the return from entrepreneurship.
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Profit = Total revenue (TR) Total cost (TC)–
Entrepreneurs maximise their profits in order to satisfy as many of their wants as possible.
Economists assume that profit maximisation is the major objective of most surviving private enterprises.
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B. Market share maximisation
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The market share of a firm in a particular industry refers to the percentage of the firm’s product sales to the industry’s product sales.
Product sales can be measured by:
$$ $
$$$
$$$$$
1. Sales revenue 2. Sales volume
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B. Market share maximisation
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Market share =Firm’s sales revenue Industry’s total sales revenue
Firm’s sales volume Industry’s total sales volume
Market share =
$$ $
$$$
$$$$$
1. Sales revenue 2. Sales volume
More common
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B. Market share maximisationIs their understanding of market share the same?
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Answers will be provided in the final version.
We’ve the largest market share because our sales revenue is the largest in the market!
We’ve the largest market share because our sales volume is the largest in the market!
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B. Market share maximisationWhy do some firms aim to maximise their market shares?
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The largest market share may NOT bring the firm the largest profit.
Maximise market share
Become dominant in the market
Have greater market power
Earn more profit later
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B. Market share maximisationMust market share maximisation be consistent with profit maximisation? Why do some dot-com companies try to maximise their market share even if they suffer great losses as a result?
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Answers will be provided in the final version.
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C. Corporate social responsibilityCorporate social responsibility refers to the responsibility of a firm to society and all its stakeholders.
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Who are the stakeholders?
People who affect or are affected by the decisions and behaviour of the firm.
c. Suppliers
b. Customers
d. The government
e. The community
a. Shareholders
Which of the following parties can be stakeholders of a firm?
f. Employees
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C. Corporate social responsibilityWhy does a firm take up social responsibility?
1. Establish goodwill
2. Attract customers, employees and investors
3. Promote business growth
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C. Corporate social responsibilityExamples of social responsibility include:
1. Obeying the laws set by the government
2. Treating and paying their employees fairly
3. Being trustworthy enterprises to their customers and trading partners
4. Protecting the environment as well as conserving energy and resources
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Economics at work 14.1Examples of corporate social responsibility
1. The Hongkong & Shanghai Banking Corporation (HSBC)
Scholarship
Business Environment Council
The HKCSS – HSBC Social Enterprise Business Centre
The HSBC Volunteers Scheme
Fig. 14.3 Kindergarten subsidised by the HSBC
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Economics at work 14.1Examples of corporate social responsibility
2. Sun Hung Kai Properties (SHKP)
Has issued sustainability reports since 2011
Spent nearly HK$100 million on designing and constructing City Art Square in Sha Tin
Has organised social, cultural and welfare activities for its employees
Fig. 14.4 City Art Square designed and constructed by SHKP Charitable Fund
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D. Provision of non-profitmaking goods and services
Some private firms provide goods or services to serve the needs of targeted groups for non-profitmaking purposes.
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a. Breakthrough runs Youth Village for youths.
b. Tung Wah Group of Hospitals provides medical services to serve low-income earners.
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Economics at work 14.2Social enterprises in Hong Kong
In Hong Kong, social enterprise is defined as a business which aims to achieve specific social objectives.
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‘Enhancing Self-Reliance Through District Partnership Programme’ supports the development of social enterprises.
Fig. 14.6 A cafeteria operated by Richmond Fellowship of Hong Kong
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Go further 14.1Why is profit maximisation assumed to be the major objective of most private enterprises?
Profits are the major source of capital for private firms to survive and develop.If a firm is not maximising its profits:
it may have fewer source of capital;
its growth will be hindered;
it will more likely be beaten down.Thus, we assume that the major objective of most surviving private firms is: Profit maximisation
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Discuss 14.1Suppose Benjamin in ‘Task 14.1’ decides to maximise his bakery’s profits. What should be done to maximise his profits?
Answers will be provided in the final version.
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14.2 Determination of profit-maximising output
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14.2 Determination of profit-maximising output
In a price-taking market, individual sellers cannot influence the price (P).
They must sell at the same market price. But they can choose their quantities supplied (Q). The output at which a firm can maximise its profit is
called the profit-maximising output.
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14.2 Determination ofprofit-maximising output
Two approaches to determine the profit-maximising output:
A. Total revenue and total cost approach
B. Marginal revenue and marginal cost approach
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A. Total revenue and total cost approachThis approach uses total revenue (TR) and total cost (TC) to find the profit-maximising output.
1. Definitions
a. TR = P × Qb. TC = The cost of producing a given quantity of outputc. Total profit = TR – TC
2. Condition for profit maximisation
A firm produces output at a point where the difference between total revenue and total cost is the greatest.
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3. Example
Price($)
Output(units)
Total revenue (= P × Q) ($)
Total cost ($)
Total profit = (TR – TC) ($)
8 0 18 1 38 2 78 3
138 4
218 5
318 6
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A. Total revenue and total cost approach
Price-taking:Sell at the market price ($8)
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3. Example
Price($)
Output(units)
Total revenue (= P × Q) ($)
Total cost ($)
Total profit = (TR – TC) ($)
8 0 18 1 38 2 78 3
138 4
218 5
318 6
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A. Total revenue and total cost approach
081624324048
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3. Example
Price($)
Output(units)
Total revenue (= P × Q) ($)
Total cost ($)
Total profit = (TR – TC) ($)
8 0 18 1 38 2 78 3
138 4
218 5
318 6
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A. Total revenue and total cost approach
081624324048
0 – 1 = -18 – 3 = 5
16 – 7 = 9 24 – 13 = 11 32 – 21 = 11 40 – 31 = 9 48 – 43 = 5
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3. Example
Price($)
Output(units)
Total revenue (= P × Q) ($)
Total cost ($)
Total profit = (TR – TC) ($)
8 0 18 1 38 2 78 3
138 4
218 5
318 6
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A. Total revenue and total cost approach
081624324048
0 – 1 = -18 – 3 = 5
16 – 7 = 9 24 – 13 = 11 32 – 21 = 11 40 – 31 = 9 48 – 43 = 5
The largest
Profit-maximising output
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3. Example
Price($)
Output(units)
Total revenue (= P × Q) ($)
Total cost ($)
Total profit = (TR – TC) ($)
8 0 18 1 38 2 78 3
138 4
218 5
318 6
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A. Total revenue and total cost approach
081624324048
0 – 1 = -18 – 3 = 5
16 – 7 = 9 24 – 13 = 11 32 – 21 = 11 40 – 31 = 9 48 – 43 = 5
The largest
Profit-maximising output
Why not this one?(To be discussed later)
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3. Example
Price($)
Output(units)
Total revenue (= P × Q) ($)
Total cost ($)
Total profit = (TR – TC) ($)
8 0 18 1 38 2 78 3
138 4
218 5
318 6
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A. Total revenue and total cost approach
081624324048
0 – 1 = -18 – 3 = 5
16 – 7 = 9 24 – 13 = 11 32 – 21 = 11 40 – 31 = 9 48 – 43 = 5
Total fixed cost
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Task 14.2The total monthly profit at Benjamin’s bakery is $12,000 and its monthly rent is $2,000. The owner knows that the market price of bread is $8 and that he can sell all his bread (6,000 units per month) at that price.
1. If the cost of producing an additional unit of bread is $6, should Benjamin produce it? Why?
Answers will be provided in the final version.
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Task 14.2The total monthly profit at Benjamin’s bakery is $12,000 and its monthly rent is $2,000. The owner knows that the market price of bread is $8 and that he can sell all his bread (6,000 units per month) at that price.
2. If the cost of producing an additional unit of bread is $10, should Benjamin produce it? Why?
Answers will be provided in the final version.
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Task 14.2The total monthly profit at Benjamin’s bakery is $12,000 and its monthly rent is $2,000. The owner knows that the market price of bread is $8 and that he can sell all his bread (6,000 units per month) at that price.
3. If the monthly rent was $20,000 (instead of $2,000), other things being constant, should he decrease or increase the amount of bread he produces? Why?(Hint: Think of how he would make the decision in the short run and long run.)Answers will be provided in the final version.
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B. Marginal revenue and marginal cost approach
This approach uses marginal revenue (MR) and marginal cost (MC) to find the firm’s profit-maximising output.
1. Definitions
a. MR of nth unit = TR of n units TR of (n-1) units–
Price($)
Output (units)
Total revenue($)
MR ($)
8 0 0 －8 1 88 2 16
TRn – TR(n-1) = MRn
8 – 0 = 816 – 8 = 8
= Price
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B. Marginal revenue and marginal cost approach
1. Definitions
b. MC of nth unit = TC of n units TC of (n-1) units–
Price($)
Output (units)
Total cost($)
MC ($)
8 0 0 －8 1 38 2 7
TCn – TC(n-1) = MCn
3 – 0 = 37 – 3 = 4
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B. Marginal revenue and marginal cost approach
1. Definitions
c.Marginal profit
of nth unit = –Total profitof n units
= MR of nth unit – MC of nth unit
Output (units)
MR ($) MC ($) Marginal profit ($)
0 － － －1 8 32 8 4
8 – 3 = 58 – 4 = 4
Total profitof (n-1) units
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B. Marginal revenue and marginal cost approach
2. Profit-maximising condition
MR > MC MR < MC MR = MC
Marginal profit > 0
A firm can increase profit by producing that unit of output.
Marginal profit < 0
A firm can increase profit by cutting production of that unit of output.
Marginal profit = 0
No units with marginal profit < 0 are produced.
Profit is maximised
All units with marginal profit > 0 are produced.
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Price ($)
Output(units)
TR(= P
Q)($)
TC($)
Total profit(= TR – TC)
($)
MR (= P)($)
MC($)
Marginal profit(= MR – MC) ($)
8 0 0 1 -1 － － －8 1 8 3 5 8 2 6
8 2 16 7 9 8 4 4
8 3 24 13 11 8 6 2
8 4 32 21 11 8 8 0
8 5 40 31 9 8 10 -2
8 6 48 43 5 8 12 -4
Largest total profit
MR = MCMarginal profit = 0
3. Finding profit-maximising output by marginal revenue and marginal cost approach
Two approaches show the same profit-maximising output.
Profit-maximising output
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3. Finding profit-maximising output by marginal revenue and marginal cost approach
Output(units)
MR (= P)($)
MC($)
Marginal profit(= MR – MC)
($)
0 － － －1 8 2 6
2 8 4 4
3 8 6 2
4 8 8 0
5 8 10 -2
6 8 12 -4
0 Q
P MC8
4
P = MR
MR = MC
Profit-maximising output
8 84
The MR and MC approach can be illustrated by a graph.
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3. Finding profit-maximising output by marginal revenue and marginal cost approach
Output(units)
TR($)
TC($)
Total profit($)
MR(= P)
($)
MC($)
Marginal profit ($)
0 0 1 -1 － － －1 8 3 5 8 2 6
2 16 7 9 8 4 4
3 24 13 11 8 6 24 32 21 11 8 8 0
Total profit at 4 units of output= Profit at zero output= -$1 + ($6 + $4 + $2 + $0) = $11 = TR – TC
Two approaches show the same total profit.
+ Sum of marginal profit
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Learning tips 14.1 Which one is the profit-maximising output?Produce 3 units or 4 units of output?
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Price ($)
Output(units)
TR(= P ×
Q)($)
TC($)
Total profit(= TR – TC)
($)
MR (= P)($)
MC($)
Marginal profit(= MR – MC) ($)
8 3 24 13 11 8 6 2
8 4 32 21 11 8 8 0
Marginal profit of the 4th unit is $0.
Production of that unit does not affect the total profit. Production of that unit can enlarge the market share. Therefore, economists suggest that the firm produces
4 units.
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Discuss 14.2Given that a firm earns a positive profit, use the marginal revenue and marginal cost approach to explain why the change in fixed cost cannot affect the firm’s profit-maximising output level.
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Answers will be provided in the final version.
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Test yourself 14.1
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Output(units) MC ($) MR
($)
0 － －1 3
2 4
3 5
4 6
5 7
The table on the right shows the marginal cost schedule of Firm A. Suppose this price-taking firm has a fixed cost of $2 and charges a uniform price of $5 (i.e., charges the same price for all units). Complete the table, and find the profit-maximising output and the corresponding profit.
Answers will be provided in the final version.
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Past exam Q1. Refer to the following table showing the production costs of a
price-taking firm.
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A. the firm will produce 5 units of output to maximize its profit.B. the maximum profit the firm can make is $5.C. the average variable cost is $5 when the firm maximizes its
profit.D. the minimum total cost of the firm is $13.
(HKDSE 2012, Q9)
Total output (units) 2 3 4 5 6Marginal cost ($) 4 6 8 10 12Average variable cost ($) 3 4 5 6 7Fixed cost ($) 1 1 1 1 1
If the product price is $6,
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14.3 Marginal cost schedule= Supply schedule
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14.3 MC schedule = Supply scheduleA price-taking firm’s marginal cost schedule is actually its supply schedule.
Output(units)
MC($)
Price = MR($)
Quantity supplied(units)
1 3
2 4
When the price is $3, the firm will take and sell at the market price and hence MR = $3.
To maximise profit, the firm will choose to produce at the output where MR = MC.
3
Quantity supplied is 1 unit when the price is
$3.
1
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Output(units)
MC(units)
Price = MR($)
Quantity supplied(units)
1 3 3 1
2 4
When the price is $4, MR = MC = $4.
The profit-maximising output is 2 units.
The quantity supplied at $4 is 2 units.
4 2
14.3 MC schedule = Supply schedule
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Output(units)
MC($)
Price = MR($)
Quantity supplied(units)
1 3 3 1
2 4 4 23 5 5 34 6 6 4
2
Quantity supplied can be determined by equating MC with price.
Quantity supplied at any given price is actually the quantity on the MC schedule.
Therefore, MC schedule = Supply schedule
3
1
14.3 MC schedule = Supply schedule
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Past exam Q2. The marginal cost schedule of a firm can be interpreted as
its supply schedule in the production of a good because
50(HKDSE Sample Paper, Q8)
A. marginal cost will increase when the output of the firm increases.
B. we can tell the quantity of the good the firm plans to produce from the marginal cost schedule given the price of the good.
C. the quantity of the good the firm plans to produce depends positively on the marginal cost of producing the good.
D. we can tell the price of the good from the marginal cost schedule given the quantity of the good.
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Past exam Q3. Which of the following are features of a perfectly
competitive market?
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(HKDSE Practice Paper, Q16)
(1) The marginal revenue of each firm equals the market price.
(2) The sellers and buyers have perfect market information.
(3) The marginal cost schedule of a firm is the same as its supply schedule.
A. (1) and (2) onlyB. (1) and (3) onlyC. (2) and (3) onlyD. (1), (2) and (3)