PROFIT MAXIMIZATION

Profit Maximization



Profit Maximization

Introduction

Profit maximization is a plausible assumption to make about the motives of the decision makers who make the firm's choices. It is reasonable to assume that private firms are interested in their profits and that higher profits are better than lower profits. However, there is a longstanding controversy and large economic literature criticizing the profit-maximizing assumption as a highly unrealistic and simplistic picture of the operation and objectives of firms in modern industrial and commercial economies.

Discussion

Economists use the terms producer, supplier and firm interchangeably. A firm is defined as the unit that employs factors of production to produce commodities that it sells producers, individuals or to the government. To understand the theory of the firm, we assume that:

(a) Each firm takes consistent decisions as if it were made up of a single individual. This means we ignore the internal problems of who reaches particular decisions and how they are reached.

(b) Each firm takes the decision with respect to a single goal, which is to make as much profit as possible i.e. profit maximization.

(c) Firms are the principal users of factors of production. Based on the assumption of profit-maximization (or cost minimization), the firm is described as “rational” or a profit maximizer. Any firm that is maximizing profit will certainly want to be producing its chosen output level at the minimum possible cost. By producing this output level at lower cost may increase profit (Koplin, 2000).

An important characteristic of the behaviour of an entrepreneur is that he always wants to make the most of his resources for achieving maximum profit. Profit Maximization is one of the fundamental assumptions of economic theory. It will be achieved when a firm reaches the stage of equilibrium. A firm is said to have reached equilibrium when it has no tendency to change its level of output, that is, when it has no tendency either to increase or decrease its level of output.

The entrepreneur got to have a sound understanding as to what thing should be maximized with a view of maximizing profits. An entrepreneur's income consists of two elements. First is that he gets wages for his work of routine management and supervision. It is the part of other costs which he incurs, for producing goods and services. Entrepreneur's wages of management and supervision are not something which he wants to make the most of.

The oversupply of receipt as compared to expenditure is the second factor. This is the surplus of total revenue over the total cost. It is called entrepreneur's residual. This residual income is the profit of entrepreneurship proper. It is his true or net profit which the entrepreneur is assumed to maximize. Since it is assumed that the firm aims at maximizing its profit, it will, therefore, be in equilibrium when it is making maximum money profit. Therefore, it is quite clear that a firm will reach a level of equilibrium output when its profits are maximum.

Maximizing Profit

If you want to maximize profits, there are only ...