Question

Managerial Economics

• Explain how firms maximize profit. Discuss in detail.

Answer 1

The firm maximizes profit either by raising their revenue (it can be either done by increasing prices or increasing the sale of output) or reducing their cost (either by using cheap inputs or by reducing the quantity of output produced).

The revenue function = The revenue is the amount received from sale of goods and services. It can be calculated as price times quantity

Revenue = P x Q

The total cost function = The total cost is the cost incurred on the production of goods and services. In short run, some costs are fixed costs and others are variable costs. But in the long run, all costs are variable.

Cost = A + bQ

Where A is fixed cost

and bQ is total variable cost

Profit = Total Revenue - Total Cost

Now, there are two types of market:

• Perfect competition: In this type of market, there are large number of buyers and sellers dealing in homogeneous products. There is a free entry and exit of firms. The price is determined by the industry and not by the firms.

In perfect competition, the profit maximization condition for a firm is: Price = Marginal Cost

• Imperfect Competition: In this type of market, there are less number of buyers and sellers. The prices are determined by the firms themselves. The examples of market under imperfect competition are: Monopoly, Monopolistic competition and Oligopoly.

In imperfect competition, the profit maximization condition for a firm is: Marginal Revenue = Marginal Cost