Profit maximisation - Essay Example

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As applied in economics, profit maximisation refers to the long run or short run process by which the firms in the market determine the output level and price at which they would make the greatest profits. While firms strive to maximise their total revenues and minimise the…
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PROFIT MAXIMISATION PROFIT MAXIMISATION IN DIFFERENT MARKET STRUCTURES As applied in economics, profit maximisation refers to the long run or short run process by which the firms in the market determine the output level and price at which they would make the greatest profits. While firms strive to maximise their total revenues and minimise the total costs, total profits reach their maximum when the marginal revenue equals the marginal cost (Baumol and Blinder, 2012).
Profit Maximisation for pure monopoly
A pure monopoly exists in the market when there is only one seller of a product with no close substitutes (Baumol and Blinder, 2012). The single seller is the price maker in the market and institutes barriers to entry for other firms into the market. A monopolist maximises his profit at the level of output where the marginal cost equals the marginal revenue. That is MR=MC. In order to determine the profit maximising level of production, the monopolist supplements its information about the prices and market demand for data on the costs of production at different levels of output. A monopolist cannot maximise profit by charging the highest price possible (market price yielding maximum benefits). Rather, it will maximise profit at the level where the Total Revenue minus the Total Cost is the highest. The difference between TR and TC is a function of price and the quantity sold. Profit maximisation in a pure monopoly structure is presented in the figure below.
The monopoly cannot maximise its profits at the points where the MC is equal to the demand or where the average total cost equals the marginal cost. At these levels of output, the revenue generated would only be sufficient to cater for the cost of production. Rather, profit is maximised at the level of output where MR=MC.
Profit Maximisation in Oligopoly Market
An oligopolistic market structure is characterised by few but large firms in the market. In making their economic decisions, firms in this market structure consider the behaviour of other firms in the market. The reason for such consideration is because any slight changes in the prices, output or expansion may have significant effects on the profitability of the firms in the market. In an oligopolistic market, profits will be maximised at the point where the price p intersects with the marginal revenue and the marginal cost curves (Baumol and Blinder, 2012). At this point, the MC=MR and MC cut the MR in its vertical portion. Profit maximisation thus occurs at price p. When the MC shifts in the vertical part of the MR, price P does not change. The movement of MC under the oligopolistic market makes insignificant price effects and hence consumers do not gain the benefit of any reduction in costs. Oligopolistic firms, therefore, maximise their profits at the point where MC=MR and at price P. The diagram below illustrates the profit maximisation in an oligopoly market structure.

Profit Maximisation under Perfect Competition
In a perfectly competitive market, there are many firms in the market that offer homogeneous products. The buyers in this market are the price makers. No single firm, therefore, can maximise its profits or welfare by charging higher prices since sellers and buyers have a perfect knowledge of the market. In this market, the sellers can sell as much as they produce at the market price. Their Total Revenue, therefore, is a product of the Total Quantity (Q) sold and Price (P). TR=Q*P. The marginal revenue in this situation equals the market price (Baumol and Blinder, 2012). The marginal cost varies with the output. In order to maximise the profits, a firm will produce up to the point where the MC equals the market price P. The MR of any additional unit produced equals the market price P. Therefore, MR=MC=P. At the point where this condition is fulfilled, a firm in the perfectly competitive market maximises its profits. The diagram below gives an illustration.

Profit maximisation occurs at the point where P=MR=MC.
Baumol, W. and Blinder, A. (2012). Microeconomics. Mason, OH: South-Western, Cengage Learning. Read More
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