Question

Describe the Behavior of the Profit-Maximizing Firm. How does the firm account for costs? Define and explain the two types of costs associated with production? How do decisions change from the short-run to the long-run?

Answer 1

Behavior of profit maximizing firm

Profit maximization both in the short run and long run it’s whereby the firms determines the price of a final product and total output. The output should have returns with the greatest profits. The total revenues should equal the total costs and firm maximizes profits where marginal costs = marginal revenues. Company gets its revenues from the sale of goods and services. We should note that Profits = Total Revenue - Total Costs.

When marginal profit is positive then quantity sold should be more therefore it should be produced more, if the marginal profit is negative then there should be less production of goods because marginal revenue is less than marginal cost but if the marginal profit is zero then this is where profits are maximized. Reason behind this is that profits rises when marginal profit is positive.

The intersection of MR and MC represents a competitive market.

How a firm account its costs

Cost accounting it’s a process where a firm collects, records. Classifies, analyzes, summarizes and evaluates data on how to effectively control its running costs. Tis data contains the information that management wants to make critical decisions concerning the firm. The production costs are controlled effectively after generating an internal report and its categorized differently. E.g. salaries, products, process of production, internal planning etc.

Types of Costs

Fixed costs – these costs occur only on the short run period. Businesses and firms must incur these types of cost which includes; rent, buying equipment, building, employee ages, vehicle etc. these costs must be incurred regardless of the firm’s success. They cannot be increased or decreased.

Variable costs – these types of costs changes with the level of the firm’s output. It can be increased or decreased depending on the firm’s performance. E.g. employees can be increased or laid off depending on the business performance

Decisions between long run and short run

Firms can make changes in the long run depending on the following factors because they can be adjusted

• The firm can enter an industry due to high profits or leave the industry if it makes losses
• It can also either expand or downsize depending on profits and losses incurred

In the short run the firm’s goal is to maximize profits where it can

• Increase production if MC is less than MR
• It can leave the market if the firm’s variable costs exceed output prices
• Downsize its production if MC is greater than MR