Profit

Maximization
DR. MIRABEL A. REYES

ECO1 BASIC MICROECONOMICS

1 S T S E M E S T E R S .Y. 2 0 2 3 - 2 0 2 4
Objectives
At the end of the lesson, the students should be able to:
1. explain how a competitive firm determines its profit-maximizing level of
output given the demand and cost data;
2. explain how a less than purely competitive firm determines its profit –
maximizing level of output and the price that will be set given the demand and
cost data;
3. identify a competitive firm’s short-run supply curve;
4. apply c marginal analysis to determine the profit-maximizing or loss-
minimizing level of output;
Objectives
5. Explain why a firm must continue operating at the loss-minimizing level of
output;
6. Explain why a firm should shut down in the short-run if market price falls
below the average variable cost;
7. Estimate costs, revenue and profit using the graph;
8. Apply the break even formula to determine a firm’s break-even output;
9. Cite the importance of calculating break-even quantity;
10. Create a small scale business plan and estimate its break-even quantity.
Total Revenue – Total Cost Approach
The Total Revenue comprises the total proceeds one receives from selling a
particular quantity of goods at a specific price.
TR = P x Q
As long as revenue exceeds cost, the firm realizes profit. Total Profit is maximized
when the firm produces output at a level at which the gap between Total
Revenue and Total Cost is at its widest.
Break-even Point

The Break-even Point is found at the output level where Total Revenue and Total Cost are equal.

The firm receives zero economic profit.

Q Price TR TVC TC Profit

0 150 0 0 100 -100
1 150 150 100 200 -50
2 150 300 180 280 20
3 150 450 300 400 50
4 150 600 450 550 50
5 150 750 620 720 30
6 150 900 800 900 0
Marginal Revenue and Marginal Cost Approaches
Marginal Revenue is the additional revenue a firm gets out of selling one extra output.

MR = Change in TR = (TR2 – TR1)

Change in Q (Q2 – Q1)

Marginal Cost is the additional cost of producing an extra unit of output.

MC = Change in TC = (TC2 – TC1)

Change in Q (Q2 – Q1)

Example : Profit Maximizing Case
Q Price TVC TC AVC ATC P = AR = MR MC Profit Comparison Course of Action
0 150 0 100 0 0 - - -100 - -
1 150 100 200 100.00 200.00 150 100 -50 MR > MC Expand Output
2 150 180 280 90.00 140.00 150 80 20 MR > MC Expand Output
3 150 300 400 100.00 133.33 150 120 50 MR > MC Expand Output
4 150 450 550 112.50 137.50 150 150 50 MR = MC Profit is Maximized
5 150 620 720 124.00 144.00 150 170 30 MR < MC Contract Output
6 150 800 900 133.33 150.00 150 180 0 MR < MC Contract Output
Notation:
As long as MR > MC , to realize more profit, a firm will have to continue to expand output.

A firm will maximize profit at the output level where MR = MC, hence the firm stops adding more
output once this is achieved.

If MR < MC, any additional output will reduce potential profit.

At times, a firm may find two MR and MC intersections. In this case, the first intersection, which
occurs at the stage of increasing returns has to be ignored. The second intersection is more
significant.
Loss Minimization

A firm respond to changes in the market. In a competitive market where sellers are
free to enter the market, a higher supply will lead to a price reduction. With a
lower price, profit may be eliminated or reduced. Thus, a firm must adjust its
output to minimize loss.
To minimize losses in the short-run, the firm must produce at the output level
where MR = MC.
Example : Loss- Minimizing Case
Supposed Price decrease from Php 150 to Php 120
Q Price= AR TVC TC AVC ATC P = AR = MR MC Profit Comparison Course of Action
0 120 0 100 0 0 - - -100.00 - -
1 120 100 200 100.00 200.00 120 100 -80.00 MR > MC Expand Output
2 120 180 280 90.00 140.00 120 80 -20.00 MR > MC Expand Output
3 120 300 400 100.00 133.33 120 120 -13.33 MR = MC Loss is Minimized
4 120 450 550 112.50 137.50 120 150 -17.50 MR < MC Contact Output
5 120 620 720 124.00 144.00 120 170 -24.00 MR < MC Contact Output
6 120 800 900 133.33 150.00 120 180 -30.00 MR < MC Contact Output
Notation:
To minimize losses in the short run, the firm must produce at the output level where MR =
MC.

Since the price of the product is still enough to cover its Average Variable Cost, that is, all
utilities, raw materials and other variable costs, the firm may continue producing despite the
loss. The firm should however, attempt to reduce Total Cost by adopting more efficient
production method and reducing wastage in the company.

The introduction of a more cost-efficient technology, substitution of cheaper inputs,

modernization of production facilities or more aggressive marketing strategy will help redeem
profit.
Shut-down Condition
The firm must shut down in the short-run if Price is not enough to cover the
Average Variable Cost ( P < AVC).
Supposed Price further falls from Php 120 to Php 80.
Q Price= AR TVC TC AVC ATC P = AR = MR MC Profit Comparison Course of Action
0 80 0 100 0 0 - - -100.00 - -
1 80 100 200 100.00 200.00 80 100 -120.00 MR < MC Stop operating
2 80 180 280 90.00 140.00 80 80 -60.00 MR = MC Stop operating
3 80 300 400 100.00 133.33 80 120 -53.33 MR < MC Stop operating
4 80 450 550 112.50 137.50 80 150 -57.50 MR < MC Stop operating
5 80 620 720 124.00 144.00 80 170 -64.00 MR < MC Stop operating
6 80 800 900 133.33 150.00 80 180 -70.00 MR < MC Stop operating
Summary
A firm refers to MR and MC level to determine its optimum output level
MR = MC
A firm refers to AR and ATC to calculate profit or loss
If AR > ATC, profit is realized
If AR < ATC, loss is incurred
A firm refers to P and AVC to decide whether to continue operating or not
If P > AVC, continue producing
If P < AVC, shut down
Notation

A firm achieves productive efficiency when it produces at P = ATC level of output. This implies that
at the current level of output, the firm is using a technologically and economically efficient input
combination.

A firm achieves allocative efficiency when it produces at P = MC level of output. The equality
between P and MC suggests that the firm is allocating resources for the right product in the right
amount according to the needs of society.
Exercises

EXERCISE L5D1 EXERCISE L5D2

You have been hired as a consultant by a firm to
determine whether it should temporarily close
Given The following firm’s data:
shop or continue its operation despite some Fixed Cost: Php5,000,000
losses. Currently the firm has 20 workers who
are paid Php400 each. The firm produces a daily Variable Cost: Php6,000,000
output of 500 units and sells them at Php30.
The cost of other variable inputs is Php2000 per Total Revenue: Php7,000,000
day. The firm’s total cost exceed its total
revenue. The marginal cost of the last unit is Will the firm still operate or shut
Php30. Should the firm continue to operate at a down? Why ? Why not?
loss? Justify your decision by showing all your
computation
Exercises

EXERCISE L5D3 EXERCISE L5D4

Indicate whether the firm should produce or shut
down in the short-run.
What does a firm do in the short run a. TR > TC at all output level
if its Fixed Costs are Php10,000,000 b. TR < TVC at the current output level
its Variable Costs are Php9,000,000
c. TR > TFC at all output levels
and its Total Revenue is
d. MR < MC at the current output level
Php8,000,000? Will it operate or
e. P > ATC at all output level
shut-down? Why or Why not?
f. P < AVC at the current output level

e. P < ATC at all output level

Short-run Supply Curve of the Firm
A firm’s short-run supply schedule may be derived once the optimum quantities are determined
at each price level. The firm’s supply curve consists of the quantities supplied above the point
P = MC = AVC.

Given:
Q AVC ATC P = MR P = MR P = MR P = MR MC Firm's Supply Curve
0 0 0 - - - - -
Price Quantity
1 100.00 200.00 170 150 120 80 100
2 90.00 140.00 170 150 120 80 80 170 5
3 100.00 133.33 170 150 120 80 120 150 4
4 112.50 137.50 170 150 120 80 150
120 3
5 124.00 144.00 170 150 120 80 170
6 133.33 150.00 170 150 120 80 180 80 0
Break-Even Quantity
A profit seeking enterprise will always
determine how high they are from the
break even point or margin of safety. This
serves as a valuable guide to how much the BEQ = Fixed Cost
firm must sell in order to make a profit from Price per unit – Variable Cost per unit
its operation. The firm should be able to
make the necessary adjustment to its
selling price, fixed or variable expenses BEQ = Fixed Cost + Desired Profit
should it find the break-even point
Unit Selling Price – Unit Variable Cost
unsatisfactory.
Sample Problem
Supposed that Judy’s Bakeshop sells large crunchy chocolate bit cookies at Php125 per piece
and the following are the cost data:
Fixed Cost per Month Variable Cost per Cookie
Rent Php8000 Chocolate Php30
Utilities Php3000 Special Dough Php50
Labor Php15000

Using the data, the monthly break-even quantity of cookies is:

BEQ = 26,000 = 26,000 = 577.78 or 578 units

125 - 80 45
Exercise L5D5
1. Using the data of Judy’s Bakeshop, suppose that the firm wants to earn a profit of Php5,000
per month. How much quantity must it sell?

2. Suppose that Judy’s Bakeshop is confident it can sell 600 cookies per month but wants to earn
Php5,000 for it, how much must it charge for a cookie?

3. Suppose that the cookie dough cost increases fromPhp50 to Php70 while other costs remain
the same. How many cookies need to be sold to break-even assuming that the price remains at
Php125 per piece and the desired profit remains at Php5,000 per month?

4. What price must it charge per cookie if it believes it can sell 600 cookies per month. Use the
new unit variable cost.
Profit Maximization (Mathematical Approach)
Given the firm’s total cost function, TC = 2,000 + Q and its demand function , P = 50 - 0.1Q
determine the profit-maximizing or loss minimizing output. Calculate its profit or loss.

Steps:

1. Derive MR and MC function from TR and TC

2. Get the derivative of TC

TC = 2,000 + Q

MC = dTC/dQ

MC = 1
Profit Maximization (Mathematical Approach)
3. Get the derivative of TR 5. Solve for TR and TC

TR = P x Q TR = P x Q

TR = (50 - 0.1Q)Q = 25.50 (245)

= 50Q – 0.1Q2 = Php6,247.50
MR = dTR/dQ TC = 2,000 + Q
MR = 50 – 0.2Q = 2,000 + 245
4. Equate MR to MC
= Php2,245
50 – 0.2Q = 1
6. Compute for Profit
49 = 0.2Q
TR - TC
245 = Q
Php6,247.50 - Php2,245 = Php4,002.50
P = 50 – 0.1 (245) = Php25.50
Exercise L5D6
Find the 1st Derivative of each of the following functions:
1. TC = 5000 – 5Q + 0.2Q2
2. Q = -77
3. P = 5Q + 20Q2 – Q
4. TC = 10Q7
Exercise L5D7

Find the profit maximizing output if demand for the product is given as
Qd = 150,000- 10,000P and the Total Cost is TC = 20,000 + 2Q
Sample Problem:
Requirements:
Giant Screen TV, Inc. is a San Diego-based
importer and distributor of 60 inch screen, 1. Calculate output, Marginal Cost, Average Cost,
high resolution TV for individual and Price and Profit at the Profit –maximizing output
level.
commercial customers. Revenue and cost
relations are as follows: 2. Calculate output, Marginal Cost, Average Cost,
Price and Profit at the Average Cost –minimizing
TR = $1,800Q – $0. 006Q2 output level.
TC = $12,100,000 + $800Q + $ 0.004Q2 3. Calculate output, Marginal Cost, Average Cost,
Price and Profit at the Short-run Revenue–
MR = $ 1,800 - $ 0.012Q
maximizing output level.
MC = $ 800 + $0.008Q 4. Summarize your findings through a chart or table.
Compare and discuss your answer for 1 and 2.
Solution for Requirement No. 1
Solving for Output Quantity @ MR = MC Solving for Marginal Cost
1800 -0.012Q = 800 + 0.008Q MC = $ 800 + $0.008Q
1800 – 800 = 0.008Q + 0.012Q MC = 800 + 0.008 (50000)
1000 = 0.02Q MC = 800 + 400
1000/0.02 = Q MC = 1200
50000 = Q
Solution for Requirement No. 1
Solving for Average Cost Solving for the Price
AC = Total Cost/Quantity = TC/Q Price = Total Revenue/Quantity = TR/Q
TC = $12,100,000 + $800Q + $ 0.004Q2 TR = $1,800Q – $0. 006Q2
TC = 12,100,000 + 800(50000) + 0.004(50000)2 TR = 1800(50000) – 0.006(50000)2
TC = 12,100,000 + 40,000,000 + 10,000,000 TR = 90,000,000 – 15,000,000
TC = 62,100,000 TR = 75,000,000
AC = 62,100,000/50000 Price = 75,000,000/50,000
AC = 1242 Price = 1500
Solution for Requirement No. 1

Solving for Profit

Profit = Total Revenue – Total Cost =
TR – TC
Total Revenue = 75,000,000
Total Cost = 62,100,000
Profit = 75,000,000 – 62,100,000
Profit = 12, 900,000
Solution for Requirement No. 2
Solving for Output Quantity @ MC = TC/Q Solving for Marginal Cost
800 + 0.008Q = (12100000 + 800Q + 0.004Q2)/ Q
MC = $ 800 + $0.008Q
800 + 0.008Q = 12100000/Q + 800 +0.004Q

800 – 800 = 12100000/Q – 0.008Q +0.004Q

MC = 800 + 0.008 (55000)
0 = 12100000/Q – 0.004Q MC = 800 + 440
0.004Q = 12100000/Q
MC = 1240
0.004Q2 = 12100000

Q2 = 12100000/0.004

Q = √3025000000 (square root)

Q = 55000
Solution for Requirement No. 2
Solving for Average Cost Solving for the Price
AC = Total Cost/Quantity = TC/Q Price = Total Revenue/Quantity = TR/Q
TC = $12,100,000 + $800Q + $ 0.004Q2 TR = $1,800Q – $0. 006Q2
TC = 12,100,000 + 800(55000) + 0.004(55000)2 TR = 1800(55000) – 0.006(55000)2
TC = 12,100,000 + 44,000,000 + 12,100,000 TR = 99,000,000 – 18,150,000
TC = 68,200,000 TR = 80,850,000
AC = 68,200,000/55000 Price = 80,850,000/55,000
AC = 1240 Price = 1470
Solution for Requirement No. 2

Solving for Profit

Profit = Total Revenue – Total Cost =
TR – TC
Total Revenue = 80,850,000
Total Cost = 68,200,000
Profit = 80,850,000 – 68,200,000
Profit = 12, 650,000
Solution for Requirement No. 3
Solving for Output Quantity @ Maximum Solving for Marginal Cost
Revenue

MR = 0
MC = $ 800 + $0.008Q
MR = $ 1,800 - $ 0.012Q MC = 800 + 0.008 (150000)
1800 - 0.012Q = 0 MC = 800 + 1200
- 0.012Q = - 1800
MC = 2000
Q = -1800/-0.012

Q = 150,000
Solution for Requirement No. 3
Solving for Average Cost Solving for the Price
AC = Total Cost/Quantity = TC/Q Price = Total Revenue/Quantity = TR/Q
TC = $12,100,000 + $800Q + $ 0.004Q2 TR = $1,800Q – $0. 006Q2
TC = 12,100,000 + 800(150000) + 0.004(150000)2 TR = 1800(150000) – 0.006(150000)2
TC = 12,100,000 + 120,000,000 + 90,000,000 TR = 270,000,000 – 135,000,000
TC = 222,100,000 TR = 135,000,000
AC = 222,100,000/150000 Price = 135,000,000/150,000
AC = 1480.67 Price = 900
Solution for Requirement No. 3

Solving for Profit

Profit = Total Revenue – Total Cost =
TR – TC
Total Revenue = 135,000,000
Total Cost = 222,100,000
Profit = 135,000,000 – 222,100,000
Profit (Loss) = - 87,100,000
Solution for Requirement No. 4

Output Marginal Cost Average CostPrice Profit

Maximizing Profit 50000 1200 1242 1500 12900000
Minimizing Cost 55000 1240 1240 1470 12650000

To minimize Cost is not worth it as the savings gained is only $ 2.00

To maximize Profit is more beneficial as the additional profit amounts to $ 250,000
(12,900,000 - 12,650,000) from minimizing cost.
Exercise L5D8
Desktop Publishing Software, Inc. develops and markets Requirements:
software packages for business computers. Although sales
have grown rapidly during recent years, the company’s 1. Calculate monthly quantity, price, total revenue,
management fears that a recent onslaught of new total cost and Profit at the short-run Profit –
competitors may severely retard future growth maximizing output level.
opportunities. Therefore, it believes that the time has
2. Calculate monthly quantity, price, total revenue,
come to “get big or get out”. The marketing and
total cost and Profit at the short-run Average Cost –
accounting departments have provided management with
the following monthly demand and cost information: minimizing output level.

3. Calculate monthly quantity, price, total revenue,

P = $ 1000 - $ 1Q
total cost and Profit at the Short-run Revenue–
TC = $ 50000 + $ 100Q maximizing output level.

MR = $ 1000 - $2Q 4. Summarize your findings through a chart or table.

Compare and discuss your answer for 1 and 2.
MC = $100
References:
Books:
1. Cruz, Milagros A., (n.d.) A Study Guide: Microeconomics, Self publication.
2. Cruz, Milagros A. (2017) Business Economics, Anvil Publishing, Inc.
Mandaluyong City, Philippines. ISBN 978-971-27-3325-3
Images
http://courses.byui.edu/ECON_150/ECON_150_Old_Site/images/7-2_SR_Pure_
Competiton_07.jpg
References:
Images
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https://www.economicsdiscussion.net/wp-content/uploads/2016/04/clip_image
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References:
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mize+profit+where+MR+%3D+MC.jpg
https://www.reviewecon.com/wp-content/uploads/2018/07/monopoly-price-cei
lings-allocatively-efficient.png
References:

Images
https://slideplayer.com/slide/16316261/95/images/25/Determining+Profits+Gra
phically%3A+The+Shutdown+Point.jpg
https://www.investopedia.com/thmb/2PpBHbYCvTdUTaXSckUEtNewIEA=/1500x
0/filters:no_upscale():max_bytes(150000):strip_icc()/Break-EvenAnalysis_Final_4
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References:
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https://images.ctfassets.net/kj4bmrik9d6o/2P22HZg3IMVHKHTKAz2GLP/a8da92
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gate01/85/profit-maximization-6-320.jpg?cb=1665768004
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