Transcript profit-maximising output

Chapter 14
Profit maximisation and
output determination
To begin with …
14.1 Objectives of private enterprises
14.2 Determination of
profit-maximising output
14.3 Marginal cost schedule = Supply
schedule
1
Chapter 14
To begin with …
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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Chapter 14
Task 14.1
Benjamin runs a bakery. He is facing some problems in
his business and is thinking of the ways to deal with them.
Earn more profit to buy
a diamond ring
Enlarge customer base
to expand my business
Livelihood of the cashier
Want the poor to
enjoy my bread
and cakes
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Chapter 14
Task 14.1
If you were Benjamin, what would you do?
Answers will be provided in the final version.
Earn more profit to buy
a diamond ring
Enlarge customer base to
expand my business
Livelihood of the cashier
Want the poor to
enjoy my bread
and cakes
4
Chapter 14
14.1 Objectives of private
enterprises
5
Chapter 14
14.1 Objectives of private enterprises
Objectives of private enterprises
Profit
maximisation
Market share
maximisation
Corporate
social
responsibility
Provision of
non-profitmaking
goods and
services
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Chapter 14
A. Profit maximisation
Profit is the net receipts of a firm or the return from
entrepreneurship.
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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Chapter 14
B. Market share maximisation
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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Chapter 14
B. Market share maximisation
1. Sales revenue
2. Sales volume
$
$
$ $
$ $
$
$ $ $ $
Market share =
Firm’s sales revenue
Industry’s total sales revenue
Market share =
Firm’s sales volume
Industry’s total sales volume
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Chapter 14
B. Market share maximisation
Is their understanding of market share the same?
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!
Answers will be provided in the final version.
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Chapter 14
B. Market share maximisation
Why do some firms aim to maximise their market shares?
Maximise
market share
Become
dominant in
the market
Have greater
market power
Earn more
profit later
The largest market share may NOT
bring the firm the largest profit.
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Chapter 14
B. Market share maximisation
Must 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?
Answers will be provided in the final version.
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Chapter 14
C. Corporate social responsibility
Corporate social responsibility refers to the responsibility of
a firm to society and all its stakeholders.
Who are the stakeholders?
People who affect or are affected by the decisions and
behaviour of the firm.
Which of the following parties can be stakeholders of a firm?
a. Shareholders
d. The government
b. Customers
e. The community
c. Suppliers
f. Employees
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Chapter 14
C. Corporate social responsibility
Why does a firm take up social responsibility?
1. Establish goodwill
2. Attract customers, employees and investors
3. Promote business growth
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Chapter 14
C. Corporate social responsibility
Examples 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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Chapter 14
Economics at work 14.1
Examples 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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Chapter 14
Economics at work 14.1
Examples 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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Chapter 14
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.
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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Chapter 14
Economics at work 14.2
Social enterprises in Hong Kong
In Hong Kong, social enterprise is defined as a business
which aims to achieve specific social objectives.
‘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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Chapter 14
Go further 14.1
Why 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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Chapter 14
Discuss 14.1
Suppose 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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Chapter 14
14.2 Determination of
profit-maximising output
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Chapter 14
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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Chapter 14
14.2 Determination of
profit-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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Chapter 14
A. Total revenue and total cost approach
This approach uses total revenue (TR) and total cost
(TC) to find the profit-maximising output.
1. Definitions
a. TR = P × Q
b. TC = The cost of producing a given quantity of output
c. 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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Chapter 14
A. Total revenue and total cost approach
3. Example
Price Output
($)
(units)
8
0
8
1
Total revenue
(= P × Q) ($)
Total
Total profit =
cost ($) (TR – TC) ($)
Price-taking: 1
3 price ($8)
Sell at the market
8
8
8
8
2
3
4
5
7
13
21
31
8
6
43
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Chapter 14
A. Total revenue and total cost approach
3. Example
Price Output
($)
(units)
8
0
8
1
Total revenue
(= P × Q) ($)
0
8
Total
Total profit =
cost ($) (TR – TC) ($)
1
3
8
8
8
8
2
3
4
5
16
24
32
40
7
13
21
31
8
6
48
43
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Chapter 14
A. Total revenue and total cost approach
3. Example
Price Output
($)
(units)
8
0
8
1
Total revenue
(= P × Q) ($)
0
8
Total
Total profit =
cost ($) (TR – TC) ($)
1
0 – 1 = -1
3
8–3=5
7
16 – 7 = 9
24 – 13 = 11
13
8
8
8
8
2
3
4
5
16
24
32
40
21
31
8
6
48
43
32 – 21 = 11
40 – 31 = 9
48 – 43 = 5
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Chapter 14
A. Total revenue and total cost approach
3. Example
Price Output
($)
(units)
8
0
8
1
Total revenue
(= P × Q) ($)
0
8
Total
Total profit =
cost ($) (TR – TC) ($)
1
0 – 1 = -1
The largest
3
8–3=5
8
8
8
8
2
3
4
5
16
24
32
40
7
13
21
31
8
6
48
43
Profit-maximising output
16 – 7 = 9
24 – 13 = 11
32 – 21 = 11
40 – 31 = 9
48 – 43 = 5
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Chapter 14
A. Total revenue and total cost approach
3. Example
Price Output Total revenue
($)
(units) (= P × Q) ($)
8
Why
not0 this one? 0
8
8 be discussed
1
(To
later)
16
8
2
24
8
3
32
8
4
Total
Total profit =
cost ($) (TR – TC) ($)
1
0 – 1 = -1
The largest
3
8–3=5
8
5
40
7
13
21
31
8
6
48
43
Profit-maximising output
16 – 7 = 9
24 – 13 = 11
32 – 21 = 11
40 – 31 = 9
48 – 43 = 5
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Chapter 14
A. Total revenue and total cost approach
3. Example
Price Output
($)
(units)
8
0
8
1
Total revenue
(= P × Q) ($)
0
8
Total
Total profit =
cost ($) (TR – TC) ($)
1
0 – 1 = -1
3
8–3=5
Total fixed
7 cost16 – 7 = 9
24 – 13 = 11
13
8
8
8
8
2
3
4
5
16
24
32
40
21
31
8
6
48
43
32 – 21 = 11
40 – 31 = 9
48 – 43 = 5
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Chapter 14
Task 14.2
The 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.
32
Chapter 14
Task 14.2
The 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.
33
Chapter 14
Task 14.2
The 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 $2,000),
other things being constant, should he decrease or
increase the amount of bread he produces? Why?
(Hint: Think of how he would make the decision in the
short run and long run.)
Answers will be provided in the final version.
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Chapter 14
B. Marginal revenue and marginal
cost approach
This approach uses marginal revenue (MR) and marginal
cost (MC) to find the firm’s profit-maximising output.
1. Definitions
a.
MR of nth unit = TR of n units – TR of (n-1) units
Price
($)
8
8
8
Output
(units)
0
1
2
Total revenue
MR ($)
TRn – TR(n-1) = MRn
($)
－
0
= Price
8
8–0=8
16 – 8 = 8
16
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Chapter 14
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 ($)
8
0
0
8
1
3
－
3–0=3
8
2
7
7–3=4
TCn – TC(n-1) = MCn
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Chapter 14
B. Marginal revenue and marginal
cost approach
1. Definitions
c.
Total profit – Total profit
Marginal profit
=
of n units
of (n-1) units
of nth unit
= MR of nth unit – MC of nth unit
Output (units) MR ($) MC ($) Marginal profit ($)
－
－
－
0
1
2
8
8
3
4
8–3=5
8–4=4
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Chapter 14
B. Marginal revenue and marginal
cost approach
2. Profit-maximising condition
Profit is
maximised
MR > MC
MR < MC
MR = MC
Marginal profit > 0
Marginal profit < 0
Marginal profit = 0
A firm can
increase profit by
producing that
unit of output.
A firm can
increase profit by
cutting
production of that
unit of output.
All units with
marginal profit > 0
are produced.
No units with
marginal profit < 0
are produced.
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Chapter 14
3. Finding profit-maximising output by marginal
revenue and marginal cost approach
Two approaches show the same profit-maximising output.
TR
Total profit
TC
(= P  Q)
(= TR – TC)
($)
($)
($)
Price
($)
Output
(units)
MR (= P)
($)
MC
($)
Marginal profit
(= MR – MC) ($)
8
0
0
1
-1
－
－
－
8
1
8
3
5
8
2
6
8
2
16
7
9
8
4
4
8
3
24
13
11
8
6
2
8
4
32
21
11
8
8
0
8
5
40
31
9
8
10
-2
Profit-maximising
8
6
48
output
Largest total
43
5
profit
MR = MC
8
12
Marginal
profit = 0-4
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Chapter 14
3. Finding profit-maximising output by marginal
revenue and marginal cost approach
The MR and MC approach can be illustrated by a graph.
Output
(units)
MR (= P)
($)
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
P
MC
8
P = MR
MR = MC
0
4
Profit-maximising
output
Q
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Chapter 14
3. Finding profit-maximising output by marginal
revenue and marginal cost approach
Two approaches show the same total profit.
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
2
4
32
21
11
8
8
0
Total profit at 4 units of output
= Profit at zero output + Sum of marginal profit
= -$1 + ($6 + $4 + $2 + $0) = $11 = TR – TC
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Chapter 14
Learning tips 14.1
Which one is the profit-maximising output?
Produce 3 units or 4 units of output?
TR
Total profit
TC
(= P × Q)
(= TR – TC)
($)
($)
($)
Price
($)
Output
(units)
8
3
24
13
8
4
32
21
MR (= P)
($)
MC
($)
Marginal profit
(= MR – MC) ($)
11
8
6
2
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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Chapter 14
Discuss 14.2
Given 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.
Answers will be provided in the final version.
43
Chapter 14
Test yourself 14.1
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 $5 (i.e., charges the same
price for all units). Complete the table,
and find the profit-maximising output
and the corresponding profit.
Answers will be provided in the
final version.
Output
(units)
MC ($) MR ($)
0
－
1
3
2
4
3
5
4
6
5
7
－
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Chapter 14
Past exam Q
1. Refer to the following table showing the production costs of a
price-taking firm.
Total output (units)
2
3
4
5
6
Marginal cost ($)
4
6
8
10
12
Average variable cost ($)
3
4
5
6
7
Fixed cost ($)
1
1
1
1
1
If the product price is $6,
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)
45
Chapter 14
14.3
Marginal cost schedule
= Supply schedule
46
Chapter 14
14.3 MC schedule = Supply schedule
A price-taking firm’s marginal cost schedule is
actually its supply schedule.
 When the price is $3,
the firm will take and
sell at the market price
and hence MR = $3.
 To maximise profit, the
firm will choose to
produce at the output
where MR = MC.
Output
(units)
MC
($)
Price
= MR($)
Quantity
supplied
(units)
1
3
3
1
2
4
Quantity supplied is 1
unit when the price is $3.
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Chapter 14
14.3 MC schedule = Supply schedule
 When the price is $4,
MR = MC = $4.
 The profit-maximising
output is 2 units.
Output
(units)
MC
(units)
Price
= MR($)
Quantity
supplied
(units)
1
3
3
1
2
4
4
2
 The quantity supplied
at $4 is 2 units.
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Chapter 14
14.3 MC schedule = Supply schedule
 Quantity supplied can
be determined by
equating MC with
price.
 Quantity supplied at
any given price is
actually the quantity
on the MC schedule.
 Therefore, MC
schedule = Supply
schedule
2
1
Output
(units)
MC
($)
Price
= MR($)
Quantity
supplied
(units)
1
3
3
1
2
4
4
2
3
5
5
3
4
6
6
4
3
49
Chapter 14
Past exam Q
2. The marginal cost schedule of a firm can be interpreted as
its supply schedule in the production of a good because
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.
(HKDSE Sample Paper, Q8)
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Chapter 14
Past exam Q
3. Which of the following are features of a perfectly
competitive market?
(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) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)
(HKDSE Practice Paper, Q16)
51