Lecture 13
PROFIT MAXIMIZATION

- Revenue, costs and profit
- Economic profit and accounting profit
- Marginal revenue and marginal cost
- Optimal output level

1. Definitions

1. Total revenue = Price x Quantity:
   TR = P x Q
2. Marginal revenue (MR): The additional revenue earned by a firm by selling 1 more unit of output
   • How is MR different from MRP_L?
3. Total profit = Total revenue (TR) - Total cost (TC)
   • Recall: TC = AC x Q
     

2. Accounting and economic profits

• Importance of including opportunity costs in TC
• Economic profit < Accounting profit
• The notion of zero profit
  

3. Firm's objective

• To maximize profits, by choosing optimal Q and P
  

4. Information needed

• The demand curve for the firm's output:
  - To obtain TR and MR for various values of Q
• The cost function:
  - To obtain TC and MC for various values of Q

• Big Question: At what output level are profits maximized?
• Big Answer:

  The output at which:

  • (Total revenue - Total cost) is highest, or
  • Marginal profit = 0, or
  • Marginal revenue (MR) = Marginal cost (MC)

5. Graphs needed

(a) TR, TC, Total Profit (Q is on the horizontal axis)
(b) MR, MC (Q is on the horizontal axis)