Firms profit maximizing price and quantity relationship

firms profit maximizing price and quantity relationship

If a firm decides to supply the amount Q of output and the price in the perfectly competitive At the market price, P 1, the firm's profit maximizing quantity is Q 1. How will this monopoly choose its profit-maximizing quantity of output, and what price will it charge? Profits for the monopolist, like any firm, will be equal to total. The Profit Maximization Rule is that if a firm chooses to maximize its profits, words, they used the rule Marginal Revenue = Total Cost/quantity.

Consequently, the profit maximizing output would remain the same.

Short-Run Supply

This point can also be illustrated using the diagram for the marginal revenue—marginal cost perspective.

A change in fixed cost would have no effect on the position or shape of these curves. The profit maximization conditions can be expressed in a "more easily applicable" form or rule of thumb than the above perspectives use. The additional units are called the marginal units.

Moreover, one must consider "the revenue the firm loses on the units it could have sold at the higher price" [6] —that is, if the price of all units had not been pulled down by the effort to sell more units. These units that have lost revenue are called the infra-marginal units. Thus the optimal markup rule is: Marginal cost is positive. Thus Q1 does not give the highest possible profit.

Marginal product of labor, marginal revenue product of labor, and profit maximization[ edit ] The general rule is that the firm maximizes profit by producing that quantity of output where marginal revenue equals marginal cost. The profit maximization issue can also be approached from the input side.

Markup Pricing: Combining Marginal Revenue and Marginal Cost

That is, what is the profit maximizing usage of the variable input? The marginal revenue product is the change in total revenue per unit change in the variable input.

Profit Maximization For The Price Making Firm

At your current price, estimate marginal cost and the elasticity of demand. Calculate the optimal price based on those values. If the optimal price is greater than your actual price, increase your price. Then estimate marginal cost and the elasticity again and repeat the process.

If the optimal price is less than your actual price, decrease your price. If the current price is equal to this optimal price, leave your price unchanged.

They had found that based on current marginal cost and elasticity, the price could be raised. But as they raised the price, they knew that the elasticity of demand would probably also change.

Short-Run Supply

An elasticity of 2 means that the markup should be percent to maximize profits. Shifts in the Demand Curve Facing a Firm So far we have looked only at movements along the demand curve—that is, we have looked at how changes in price lead to changes in the quantity that customers will buy.

Firms also need to understand what factors might cause their demand curve to shift. Among the most important are the following: Changes in household tastes. Starting around or so, low-carbohydrate diets started to become very popular in the United States and elsewhere. For some companies, this was a boon; for others it was a problem.

For example, companies like Einstein Bros. As more and more customers started looking for low-carb alternatives, these firms saw their demand curve shift inward.

Consider Lexus, a manufacturer of high-end automobiles. When the economy is booming, sales are likely to be very good. In boom times, people feel richer and more secure and are more likely to purchase a luxury car. But if the economy goes into recession, potential car buyers will start looking at cheaper cars or may decide to defer their purchase altogether. Many companies sell products that are sensitive to the state of the business cycle.

Their demand curves shift as the economy moves from boom to recession. In a business setting, this is a critical concern. If a competitor decreases its price, this means that the demand curve you face will shift inward. For example, suppose that British Airways decides to decrease its price for flights from New York to London. American Airlines will find that its demand curve for that route has shifted inward. If the demand curve shifts, should a firm change its price?

The answer is yes if the shift in the demand curve also leads to a change in the elasticity of demand. In practice, this is likely to be the case, although it is certainly possible for a demand curve to shift without a change in the elasticity of demand.

firms profit maximizing price and quantity relationship

The correct response to a shift in the demand curve is to reestimate the elasticity of demand and then decide if a change in price is appropriate. Complications Pricing is a difficult and delicate job, and there are many factors that we have not yet considered: We address some of them in other chapters of the book; others are topics for more advanced classes in economics and business strategy.

firms profit maximizing price and quantity relationship

By far the most important problem that we have neglected is as follows: When making pricing decisions, firms may need to take into account how other firms will respond to their decisions. That calculation presumes that competing firms keep their prices unchanged. In markets with a small number of competitors, it is instead quite likely that other firms would respond by decreasing their prices.

We have assumed throughout that a firm has to charge the same price for every unit that it sells. In many cases, this is an accurate description of pricing behavior.

Profit maximization

When a grocery store posts a price, that price holds for every unit on the shelf. But sometimes firms charge different prices for different units—by either charging different prices to different customers or offering individual units at different prices to the same customer.

You have undoubtedly encountered examples. Firms sometimes offer quantity discounts, so the price is lower if you buy more units.

firms profit maximizing price and quantity relationship

Sometimes they offer discounts to certain groups of customers, such as cheap movie tickets for students. We could easily fill an entire chapter with other examples—some of which are remarkably sophisticated.