Profit Maximization

scheduleIntroduction To Profit AndProfit MaximizationSlides from3 - 8Total Slides 6ArslanWani - 42Objective , P.Max Model , Implication , Factors & TheoriesSlides from9 - 15

Total Slides 7Javaid Iqbal - 22Total Revenue , Marginal Revenue , Marginal CostSlides from16 - 24Total Slides 9Junaid Jamal - 38Example Of Profit Max. & Its ApplicationSlides from25 - 28Total Slides 4Aabid Hussain - 39Graphs , Video & How To Maximize ProfitSlides from29 - 36Total Slides 8Muneeb Lone - 08Advantages And Disadvantages Of Profit MaximizationSlides from37 - 40Total Slides 4Qaiser Beigh - 48Profit MaximizationPresented by:Abid Hussain 39Arslan Wani 42Javaid Iqbal 22Junaid Jamal 38Muneeb Lone 08Qaiser Beigh 48

Presented to:Dr. FAROOQ AHMAD KHAN

Profit:Profit-makingis one of the most traditional, basic andmajor objectives of a firm. Profit-making is the driving-force behind all business activities of a company. It is the primary measure of success or failure of a firm in the market.

Profit earning capacityindicates the position, performance and status of a firm in the market. It is an acid test of economic ability and performance of an individual firm. There is no place for a firm unless it earns a reasonable amount of profit in the business.Earlier profit maximization was the sole objective of a firm. This assumption has a long history in economic literature and the conventional price theory was based on this very assumption about profit making. In spite of several changes and development of several alternative objectives, profit maximization has remained as one of the single most important objectives of the firm even today.

Specific efforts have been made to maximize output and minimize production and other operating costs. Costs reduction, cost cutting and cost minimization has become the slogan of a modern firm.

Profit Maximization:An Introduction.A process thatcompaniesundergo todeterminethe bestoutputandprice levelsin order to maximize itsreturn.The company will usually adjust influentialfactorssuch as productioncosts,sale prices, and outputlevelsas a way of reaching itsprofitgoal.There are twomainprofit maximization methods used, and they areMarginalCost-MarginalRevenueMethod andTotalCost-Total Revenue Method.We usually assume firm managers to maximise profits that is the difference between total revenue and total costsWe draw a distinction between economic profits and accounting profits.Economic profits = sales revenue economic cost.Account profit = sales revenue accounting cost.Economic cost include all relevant costs including opportunity costs.PM is consistent with maximising market value (i.e., stock price) of the firm.

Profit maximization is the rational behaviour ofequilibriumassumption. Any firm which aiming at profit maximization model; will go increasing its output till it reaches maximum profit output. Profit is known nothing but differences between total revenue and total cost. The more the differences between total revenue and total cost will create maximum profit. So, the equilibrium for a firm will be when there is maximum difference between the total cost and total revenue.Profit maximization is a good thing for a company, but can be a bad thing forconsumersif the companystartsto use cheaperproductsor decides to raiseprices.

Profit maximization is the most important objective of a business entity. Every business, in addition to striving for the attainment of other objectives, does its best with special importance to make profits. Profit is to be regarded as a yardstick against which are assessed or measured the quality and value and the success of a business.As has been mentioned above, profit maximization is the most necessary aspect of a business entity as it helps to run a business smoothly and successfully and survive continuously while making profits and staying solvent at the same time as providing various benefits. Objectives:The objective of a for-profit firm is to maximize profit. Profit is total revenue less the costs of the resources (land, labor, capital) used. Total revenue is the price of goods and services multiplied by the quantity sold, PQ.Profit is the difference between total revenue and total cost.

Profit = PQ Cost of land, labor and capital10Profit Maximization ModelProfitMaximizationmodelhelps to predict the price-output behaviour of a firm under changing market conditions like tax rates, wages and salaries, bonus, the degree of availability of resources, technology, fashions, tastes and preferences of consumers etc. It is a very simple and unambiguous model. It is the single most ideal model that can explain the normal behaviour of a firm. It is often argued that no other alternative hypothesis can explain and predict the behaviour of business firms better thanprofit-maximization hypothesis. This model gives a proper insight in to the working behaviour of a firm. There are well developed mathematical models to explain this hypothesis in a systematic and scientific manner.

Implication of P.Max ModelProfit-maximization implies earning highest possible amount of profits during a given period of time.A firm has to generate largest amount of profits by building optimum productive capacity both in the short run and long run depending upon various internal and external factors and forces.In the short run a firm is able to make only slight or minor adjustments in the production process as well as in business conditions. The plant capacity in the short run is fixed and as such, it can increase its production and sales by intensive utilization of existing plants and machineries, having over time work for the existing staff etc. Thus, in the short run, a firm has its own technical and managerial constraints.In the long run, as there is plenty of time at the disposal of a firm, it can expand and add to the existing capacities, build up new plants, employ additional workers etc to meet the rising demand in the market. Thus, in the long run, a firm will have adequate time and ample opportunity to make all kinds of adjustments and readjustments in production process and in its marketing strategies.

Factors Affecting P.MaxPricing and business strategies of rival firms and its impact on the working of the given firm.Aggressive sales promotion policies adopted by rival firms in the market.Without inducing the workers to demand higher wages and salaries leading to rise in operation costs.Without inducing the workers to demand higher wages and salaries government controls and takeovers.Maintaining the quality of the product and services to the customers.

Factors cont.Taking various kinds of risks and uncertainties in the changing business environment.Adopting a stable business policy.Avoiding any sort of clash between short run and long run profits in the business policy and maintaining proper balance between them.Maintaining its reputation, name, fame and image in the market.Profit maximization is necessary in both perfect and imperfect markets. In a perfect market, a firm is a price-taker and under imperfect market it becomes a price-searcher.

Theories of P.MaxEconomist Theory of Firm: According to the Economist Theory of Firm, a firm is a transformation unit, which converts input into output and while doing so, tries to create surplus value. This surplus value is nothing but the difference between the value of the product and the value of the factors of production. The firm aiming for profit maximization reaches its equilibrium only when it produces profit maximizing output. The firm maximizes profit by equating marginal revenue with marginal cost.Theories cont.Williamsons Managerial Discretionary Theory: According to the theory, in a firm, shareholders and managers are two separate groups. The firm tries to get maximum returns on investment and get maximum profit, whereas managers try to maximize profit in their satisfying function. At last, Williamsons managerial discretion theory shows the utility function of a manager. In this theory, the firm will try to get maximum returns or maximum profit where as manager try to maximum utility satisfying function. They are in equilibrium when the utility has maximum amount.

Total RevenueTotal Revenue = Price X QuantityProfit-Maximizing Level of OutputWhat happens to profit in response to a change in output is determined by marginal revenue (MR) and marginal cost (MC).A firm maximizes profit when MC = MR.MARGINAL REVENUE (MR)The change in total revenue associated with a change in quantity.The increase in revenue that results from the sale of one additional unit of output.Marginal revenue is calculated by dividing the change in total revenue by the change in output quantity. While marginal revenue can remain constant over a certain level of output, it follows the law of diminishing returns and will eventually slow down, as the output level increases.Perfectly competitive firms continue producing output until marginal revenue equals marginal cost.MARGINAL COST (MC)Change in the total cost as a result in the change of unit cost is known as Marginal cost. (Dr. Farooq Ahmad Khan)Marginal costs arevariable costsconsisting oflabourandmaterial costs,plus administrationoverheads anestimatedportion of fixed costs (such asandselling expenses). Incompanieswhereaverage costsare fairly constant, marginalcostis usually equal to average cost. However, inindustriesthat require heavycapital investment(automobileplants, airlines, mines) and havehighaverage costs, it is comparatively verylow.Theconceptof marginal cost is critically important in resourceallocationbecause, foroptimumresults, managementmust concentrate itsresourceswhere theexcessofmarginal revenueover the marginal cost is maximum. Alsocalledchoicecost,differential cost, or incremental cost.

Marginal Revenue and Marginal CostThe Profit maximizing quantity of output can be determined by comparing marginal revenue and marginal cost. Marginal cost is the additional cost of producing one more unit of output. Marginal revenue is the additional revenue from selling one more unit of output.Profit is maximized at the output level where marginal revenue and marginal cost are equal. The supply rule is: Produce and offer for sale the quantity at which MR=MC.21MR and MCMarginal Revenue = Change in Total Revenue/Change in Total OutputMR = TR/Q

Marginal Cost = Change in Total Cost/Change in Total OutputMC = TC/QComparing marginal revenue and marginal cost determines whether the firm needs to supply more or less in order to maximize profit.22MR > MCIf marginal revenue exceeds marginal cost, the production of an additional unit of output adds more to revenue than to costs.In this case, a firm is expected to increase its level of production to increase its profits.

MR < MCIf marginal cost exceeds marginal revenue, the production of the last unit of output costs more than the additional revenue generated by the sale of this unit.In this case, firms can increase their profits by producing less.A profit-maximizing firm will produce more output when MR > MC and less output when MR < MC.MR = MCIf MR = MC, however, the firm has no incentive to produce either more or less output. The firm's profits are maximized at the level of output at which MR = MC.

An example of profit max.Suppose a business that produces and sells college boards. In a typical day you produce three boards. You are able sell these boards for Rs500 a piece. You employ five workers, each of whom earns Rs15 per hour (Rs120 per day), and you work alongside them and pay yourself at the same rate. Material inputs cost Rs150 per board. Of course, you have additional "overhead" expenses, including rent, a secretary/bookkeeper, electricity, etc. and it's afixed cost which comes to Rs130 per day. Thus, your company earns a profit of P = (Rs500 x 3) - (Rs720 + 450 + 130) = Rs1500 - Rs1300 = Rs200 per day Working five days a week for 50 weeks a year, that comes to an annual profit of Rs50,000.

Suppose you decide to increase production to four boards per day. This requires you to hire two more workers (at another Rs240) and purchase another Rs150 worth of materials. Overhead expense doesn't change. Your total cost rises to Rs1690. You find that you are able to sell the fourth board for Rs500. Total revenue rises to Rs2000 per day, while total costs rise to Rs1690. Profit increases to Rs310 per dayThis nice result may lead you to increase production to five boards a day. If you are able to sell all five boards for Rs500 each, and if yourvariable costsof producing the boards - what you pay in labour and materials - doesn't increase, producing a fifth board makes sense. TR rises to Rs2500, TC rises to Rs2080, and profit increases to Rs420. So you sell five boards.Suppose, however, that you find that the labour market is so tight that you cannot hire another two workers at Rs15 per hour. In fact, to hire your ninth and tenth workers, you must pay Rs20 per hour. That increases the labour cost of the fifth board by Rs80 (Rs40 per worker times two workers). TC rises to Rs2160, which still allows profit to increase to Rs340. But we have a problem brewing. Can you really get away with paying your veteran workers Rs15 an hour, while at the same time hiring new workers at Rs20 per hour? Not likely. So when you hire the ninth and tenth workers, you are forced to raise the wages of your first eight workers. Let's recalculate profit for Q = 5. TR = Rs500 x 5 = Rs2500. TC = (Rs160 x 10) + (Rs150 x 5) + Rs130 = Rs2480. That leaves a profit of Rs20. Doesn't look like such a good idea now, Thus, if you realize that your costs will rise sharply if you produce a fifth board each day, you will decline to produce the board.APPLICATIONOur little example illustrates the situation every business owner or manager faces. Businesspeople know what their current position is (revenue and costs) and they can estimate TR and TC for a higher (or lower) level of production. By actually changing output levels, they learn by experience what their demand and cost curves look like. In the process, they discover what happens to profit as they change output levels. Through this discovery process, businesspeople seek to find the output level that maximizes profit.

As omniscient onlookers, we can describe this process a bit more analytically. A firm should increase its output so long as the marginal revenueis greater than themarginal costof those units. As long as MR > MC, profit grows. However, when MR < MC, profit shrinks. So firms expand output only to the point at which MR = MC. This point maximizes profit.

The profit-maximization rule applies both to firms that are able to sell their product at a constant price and to firms that find they must reduce the price of their product to increase sales. In the real world, firms have to engage in trial-and-error discovery processes, searching for the profit-maximization point. But the process can be succinctly described by the marginal revenue-marginal cost rule

Profit Maximization

30Profit: downward-sloping demand of price-setting firmprofitAveragecostQuantityProfit-maximizing priceQMAX0Costs andRevenueDemandMarginal costMarginal revenueAverage costBCEDShut down because P < AC at all Q: downward-sloping demand of price-setting firmQuantity0Costs andRevenueDemandAverage total costProfit Maximization: horizontal demand for a price taking firmQuantity0CostsandRevenueMCACMC1Q1MC2Q2The firm maximizesprofit by producing the quantity at whichmarginal cost equalsmarginal revenue.QMAX P = MR1 = MR2 P = AR = MRShut down because P < AC at all Q: horizontal demand for a price taking firmQuantity0CostsandRevenueMCAC P = AR = MRACminPROFIT MAXIMIZATION

How to Maximize ProfitIf marginal revenue does not equal marginal cost, a firm can increase profit by changing output.The supplier will continue to produce as long as marginal cost is less than marginal revenue.How to Maximize ProfitThe supplier will cut back on production if marginal cost is greater than marginal revenue.Thus, the profit-maximizing condition of a competitive firm is MC = MRAdvantagesProfit maximization is the basic objective of any business to survive and to remain in the money.A business which fulfils the objective from the perspective of profit maximization, can maintain sufficient funds at all times while maintaining working capital effectively and efficiently.Objective of profit maximization is leading the business organization in the direction of profitability and prosperity while safeguarding against the possibility of insolvency.

Cont.Profit maximization carries the big advantage of creating cash flow. When maximizing profit is the primary consideration, investments, reinvestments and expansions are typically tabled. In the mean time, the profits keep building, producing a healthy bottom line and increasing the firms amount of available cash.Some degree of profit maximization is always present. The goal of a company is to create profits. It has to profit from its business to stay in business. Moreover, investors and financiers in the company may require a certain level of profits to secure funds for expansion.. As such, maximizing that profit is always a consideration to some extent.DisadvantagesProfit maximization is the focus of a company on their profits ahead of everything else. This means that they will use all of the resources they have to increase profits. This process sounds like a win-win situation, but it does come with some disadvantages, namely risk. Using this type of strategy causes some risks to the company. It is possible to lose all market value if the market takes a turn while all resources are set to creating a profit.Pursuing a profit maximization strategy comes with the obvious risk that the company may be so entrenched in the singular strategy meant to maximize its profits that it loses everything if the market takes a sudden turn.Cont.If a company focuses only on maximizing its profit, it may miss opportunities for investment and expansion.Profit maximization is an inappropriate goal because it leads to inflation and irregular distribution of wealth. It also makes one run the risk of losing employees and mostly it restricts quality.If a company pursues a profit maximization strategy, it creates an environment where price is a premium and cutting costs is a primary goal. This, in turn, creates a perception of the company that could lead to a loss of goodwill with customers and suppliers.It also creates an expectation of shareholders to see immediate gains, rather than realizing profits over time.That's all Friends Thanks for Your Kind Attention..