Study notes

Profit Maximisation

  • Levels: A Level, IB
  • Exam boards: AQA, Edexcel, OCR, IB, Eduqas, WJEC

Profits are maximised when marginal revenue = marginal cost

Revision Video: Business objectives including profit maximisation

Total profit is maximised at an output level when marginal revenue = marginal cost

Consider the example in the table.

  • As price per unit declines, so demand expands
  • Total revenue rises but at a decreasing rate as shown by the column showing marginal revenue. Initially the firm is making a loss because total cost exceeds total revenue.
  • The firm moves into profit at an output level of 57 units
  • Thereafter profit is increasing because the marginal revenue from selling units is greater than the marginal cost of producing them.
  • Consider the rise in output from 69 to 75 units. The MR is £13 per unit, whereas marginal cost is £9 per unit. Profits increase from £142 to £166.

But once marginal cost is greater than marginal revenue, total profits are falling.

Price Per Unit (AR) (£)Demand / Output (units)Total Revenue (TR) (£)Marginal Revenue (MR) (£)Total Cost (TC) (£)Marginal Cost (MC) (£)Profit (£)
503316502000-350
4839187237212020-248
4645207033222217-152
4451224429231215-68
425723942523841210
406325202124441076
386926221724806142
367527001325349166
348127549261213142

As long as marginal revenue > marginal cost, total profits will be increasing (or losses decreasing). The profit maximisation output occurs when marginal revenue = marginal cost.

Maximising total profit

Showing total profits at the profit-maximising level of output

Total profits

Profit maximisation for a monopoly - revision video

Profit Maximisation - Revision Video

Benefits from aiming to maximise profits:

  1. Shareholders likely to benefit from higher dividends (a share of profits)
  2. Employees may gain if some part of their pay is linked to the profitability of the business
  3. Higher profits may lead to increased capital spending which will benefit businesses in industries such as engineering and construction

Drawbacks from aiming to maximise profits:

  1. Higher prices for final consumers which reduces their real incomes / purchasing power and means a lower level of consumer surplus
  2. High profits might act as an incentive for new firms to enter the market – depending on how contestable it is – which in the longer term might reduce the returns to shareholders as competition intensifies
  3. Companies that become overly focused on maximising profits might lose sight of the social / ethical and environmental aspect of businesses to the detriment of local communities.

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